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Effect of fiscal policy on housing finance in India Krishan, Deepa 1994

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EFFECT OF FISCAL POLICY ON HOUSING FINANCE IN INDIA by DEEPA KRISHAN B.Sc. M.Sc.  (Hons.),  University of Delhi,  India,  1974  Indian Agricultural Research Institute, New Delhi, M.Sc. University of Bath, UK.  India,  1989  A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE  in  THE FACULTY OF GRADUATE STUDIES School of Community and Regional Planning We accept this thesis as conforming to the required standard  THE UNIVERSITY OF BRITISH COLUWIBIA APRIL 1994  Deepa Krishan,  1994  1976  __  In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission.  (Signature)  Department of  Sc  The University of British Columbia Vancouver, Canada  Date  DE-6 (2/88)  ABSTRACT This  attempts  thesis  to  identify  elements  needed  in  a  fiscal  policy  designed to encourage private investment towards urban housing in India.  The  need for such a policy arises due to the existing and projected urban housing shortage in India. The Government of subsidies,  India attempts  to  tax incentives and regulation.  address  housing  However,  shortages  through  the urban housing shortage  continues to increase. One of the major constraints identified is the shortage of housing finance. An estimated investment of Rs. meet  the  existing urban housing  shortage of  572 billion is required  about  10 million units.  to  Fiscal  policy instruments are useful in directing finance towards selected priority sectors. This thesis suggests that the fiscal policies of India be designed to encourage private investment in the urban housing sector. Only a limited number of studies have been made to ascertain how fiscal policies  influence  housing  and housing  finance,  even  though  that affect housing are commonly used in many countries.  tax  incentives  These studies  show  that the effect of most housing tax expenditures is regressive. The incentives given by housing tax expenditures  directly affect  only the  tax payers,  and  thus would be limited to the top two quintiles of Indian population. People in lower income groups would not benefit and would be discriminated against by these  policies.  For  increasing  urban  housing  in  India,  there  is  need  to  suggest policy measures that favourably impact all sections of the population. A  fiscal  household  policy  savings  that  towards  helps  the  investment  in  financial urban  institutions  housing  is  to  mobilize  necessary.  These  policies can be designed to encourage the rich to invest in institutions that provide  low-cost  housing  finance  credit  ii  to  the  poorer  sections.  This  will  enable the urban dwellers,  including the poorer sections amongst them, to have  access to finance for housing at reasonable interest rates. fiscal  The housing  or  businesses provide  policy  housing  finance  invest  to  subsidized  must  in  also  their  to  housing  housing  give  for  them.  to  incentives  employees. low-income Such  to  They  employers should  groups,  incentives  also  and  would  provide  to  encourage  developers  to  also  in  reducing the role of the underground economy in the housing sector.  help  Policies  that actively discourage hoarding and speculation in land and property, as a tax on vacant land, would In India, in  the  policies,  such  increase the supply of housing.  such fiscal policies would need to be complemented by changes  regulatory  framework  to  remove  such as rent control laws,  the  deleterious  effects  on the supply of housing.  incorporating incentives to promote housing,  of  other  A tax system  formulated in coordination with  housing and urban planners, and with a provision for regular evaluation of its effectiveness  is  likely to considerably help reduce the  finance.  iii  shortage  of housing  TABLE OF CONTENTS ABSTRACT TABLE OF CONTENTS  iv  LIST OF TABLES  vi  LIST OF ABBREVIATIONS  vii  DEFINITION OF AN URBAN AREA IN INDIA  ix  ACKNOWLEDGMENTS  x  CHAPTER ONE Introduction 1.1 Introduction 1.2 Background 1.3 Problem Statement 1.4 Objectives of the study 1.5 Scope of the study 1.6 Methodology 1.7 Thesis Organization  1 1 3 4 7 7 8 8  CHAPTER TWO Housing Situation in India 2.1 Housing in Developing Countries 2.2 Condition of Housing in India 2.3 National Housing Policy  10 10 11 14  CHAPTER THREE Housing Finance in India 3.1 Housing Finance- General System 3.2 Housing Finance in India 3.3 Constraints for Housing Finance  19 19 24 32  CHAPTER FOUR Fiscal Policies Relating to Housing 4.1 Introduction 4.2 Reasons for Government Intervention in Housing 4.3 Problems associated with Public Intervention 4.4 Definition of Tax Expenditures 4.5 How Housing Enters the Tax System 4.6 Significance of the Tax Expenditure Concept to Housing Policy 4.7 Tax Expenditures and Housing Finance Markets 4.8 Curtailing Tax Efficient Housing Investment 4.9 Other Forms of Government Intervention  :iv  .  .  ..  .  .  .  .  .  .  .  ..  .  .46 46 48 50 52 52 .59 .60 .61 .61  4.10 Comparison Between Tax Expenditures and Direct Subsidies. .62 CHAPTER FIVE Housing Tax Expenditures in India 5.1 Introduction 5.2 Taxation Policies Relating to Housing in India.... CHAPTER SIX Housing Tax Expenditures in Other Countries.... 6.1 OECD Countries 6.2 Britain 6.3 Canada 6.4 United States Of America 6.5 Developing Countries  .68 .68 .69  .80 .80 .88 94 .99 .102  CHAPTER SEVEN Effects of Housing Tax Expenditures on Housing.. 7.1 Growth in Home-ownership 7.2 Urban Sprawl 7.3 Distributional Impacts and Tenure Choice.... 7.4 Tax incentives and Rental Property 7.5 Housing Credit Institutions 7.6 Tax Relief on Borrowing 7.7 Promotion of Home Ownership by Lower Income Groups 7.8 How Fiscal Preference Affects Different Income Groups  106 106 108 109 112 118 119 120 122  CHAPTER EIGHT Conclusions and Recommendations 8.1 Limitations of the Study 8.2 Conclusions 8.3 Policy Implications and Suggestions for India 8.4 Recommendations for Further Study  123 123 124 127 136  BIBLIOGRAPHY  140  V  LIST OF TABLES 2.1 Projections of Housing Requirements in India  12  2.2 Households Living in Rental Housing in India  12  3.1 Housing Investment in India  24  3.2 Rates of Gross Domestic Saving in India  39  3.3 Sources of Housing Finance in India  44  3.4 Share of Various Sources of Housing Finance in India  44  5.1 Taxation in India of Housing and Other Incomes  69  5.2 Home Loan Account Scheme in India  71  6.1 Taxation of Owner-occupied and Rental Housing in India and Selected OECD countries  87  6.2 Taxation in UK of Housing and Other Incomes  89  6.3 Tax Subsidies to Owner-occupiers in UK  90  6.4 Main Forms of Financial Subsidy by Tenure in UK  92  6.5 Housing Subsidies,  94  Taxation and Benefits in UK  6.6 Major Federal Expenditures for Housing in Canada, 6.7 Federal Housing Tax Expenditures in Canada,  1979 .95  1979  97  6.8 Changes in Home-ownership Rates in Canada  98  6.9 Changes in Renter Households in Canada  98  6.10 Major Activities subsidized by Tax Expenditures in USA.. .99 6.11 Housing Tax Expenditures for Individuals in USA 6.12 Distribution of Housing Tax Expenditures in USA,  100 1990.. .101  7.1 Home Ownership in India and Selected OECD countries  106  7.2 Households by Tenure in UK and USA  110  vi  LIST OF ABBREVIATIONS AHOP ARP  Assisted Home Ownership Program  (Canada)  .Assisted Rental Program (Canada)  BES.  Business Expansion Scheme  CMHC  Canada Mortgage and Housing Corporation  CPF  Central Provident Fund  EWS  Economically Weaker Sections  Fl  Financial Institution  GDP  Gross Domestic Product  GIC  General Insurance Corporation  GNP  Gross National Product  HDB  Housing Development Board  HDFC  Housing Development Finance Corporation  HFI  Housing Financial Institution  HIG  High Income Group  HLA  Home Loan Account  HRA  Housing Rent Assistance  HTE..  Housing Tax Expenditure  HUDCO  Housing and Urban Development Corporation  IT  Income Tax  LIC  Life Insurance Corporation  LIG  Low Income Group  MIG...  Middle Income Group  MIRAS.  Mortgage Interest Relief at Source  MITR..  Mortgage Interest Tax Relief  MURB..  Multiple Unit Residential Building  (UK)  (Singapore)  (India)  (Singapore) (India)  (UK)  vii  (India)  (India)  (UK)  (UK) (Canada)  NRA.  National Housing Act  NHB.  National Housing Bank  NHP..  National Housing Policy  NRIT.  Non-recurring Indirect Taxes  NIUA.  National Institute of Urban Affairs  OECD.  Organization for Economic Cooperation and Development  RHOSP Rs  .  (Canada) (India) (India)  (India)  Registered Home Ownership Saving Plan .Rupees  (India)  (Canada)  (22.50 Rupees  =  1 Canadian Dollar)  (31.10 Rupees  =  1 US Dollar)  TRA  Tax Reform Act  UN  United Nations  UTI  Unit Trust of India  VAT  Value Added Tax  WT  Wealth Tax  (USA)  viii  DEFINITION OF AN URBAN AREA IN INDIA 1 An urban area in India is defined as follows: (a)  All places with a municipality,  town area committee,  etc.,  corporation,  Cantonment board or notified  and  (b)  all other places which satisfy the following criteria:  (1)  a minimum population of 5,000;  (2)  at  least  pursuits; (3)  75  of  male  working  population  engaged  in  non-agricultural  and  a density of population of at least 400 persons per sq.  km.  (1000 persons  per sq. mile) An URBAN AGGLOMERATION is by definition the continuous urban spread consisting of a core town and its adjoining outgrowths,  which may be urban in their own  rights or rural. This thesis relates to urban areas having more than 100,000 persons.  Source 1  Shukia,  1988.  ix  ACKNOWLEDGMENTS The author gratefully acknowledges India,  in granting  leave of  absence  the assistance of  from her  the Government of  job and thereby providing  the  opportunity to conduct this study. The author also acknowledges the continuous support Thanks  and guidance are  also  given by Dr.  expressed  to  her  V.  Setty Pendakur  colleagues  contributed significantly to this study.  both  India  Michael and  Leaf.  Canada  who  Special thanks are also given to her  family for their constant support and patience.  x  in  and Dr.  CHAPTER ONE  INTRODUCTION 1.1 Introduction Access  to adequate and affordable  housing  challenge in many countries including India.  in urban areas  is  a major  This thesis examines the ways in  which fiscal policy has been used to attract investment to the housing sector in  India  fiscal  and  some  policy must  other have  countries.  It  to attract  then  suggests  sufficient  the  finance  features  which  for urban housing  a in  India. The  tax  system  constitutes  one  development policy in any country . 2 a desirable social goal,  of  the  most  important  instruments  of  If redistribution of income is considered  then taxation is an important means to that end,  one  that every country utilizes, whether explicitly or otherwise. Economic growth, internal  and  external  distribution  of  income  attempts  to  achieve,  Taxation  is  only  stability,  and  the  and  are  some  even  one  of  wealth though  the  they are  means  of  attainment the  of  in  the  achieving  of  goals  an that  realm of such  appropriate tax  public  national  policy  . 3 policy  objectives.  Though the potential efficacy of taxes in achieving many of these purposes has often been exaggerated, instruments appropriate  of  nevertheless,  as taxes are one of the most pervasive  government policy in any economy,  that  the  objectives as growth,  effects  of  distribution,  taxation  on  it  is both  inevitable  such  general  public  and  policy  and stability need to be taken explicitly  into account while designing the tax system. Since  Bird 3  1950,  fiscal  (1992)  p(ix)  (1992)  p 8.  policies  of  India,  1  have been  formulated not  only to  raise  revenue,  economic  also  but  objectives.  have  been  Though this  used  dual  for  role  encouraging of  tax laws  desired has  social  been  and  criticized  often as the tax laws become more complicated and the primary objective of tax laws to levy and collect taxes is compromised,  fiscal policies have achieved a  significant measure of success in India and other countries to achieve social and economic goals. In India, century. to  The urban population increased nine-fold from 25.62 million in 1901  240 million  cent  from  population, world, The  there has been rapid growth of urban population during this  1834  in l990 while the number of urban centres to  3245g.  However,  in  of  this  aggregate  urban  of  urbanization  is  its population living in urban areas.  expected  to  increase  decades, and as per estimates of The Urban Institute population  large  India continues to be one of the least urbanized countries of the  with only about 27 per cent of  level  spite  increased 80 per  rapidly (1989)  (projected to be approximately 460 million)  in  the  coming  41 per cent of the  will be living in urban  areas by the year 2010. As heavy  more  demands  necessary sanitation,  people  crowd  on  government  public  services,  electricity,  etc.  into for  the  cities,  housing  such  as  and  they the  transport,  Even at present,  will  place  provision  of  increasingly a  communication,  host  of  water,  there is considerable shortage  of urban housing and much of the housing stock available is of poor quality and often out of the reach of most of the urban poor. The 1991 Census of India estimates housing shortage in the country to be 29.8 million units,  Definition of urban areas is given in Appendix 1. 4 me Urban Institute, 5  (1989)  2  of which  9.6 million are in urban areas. The Government of India has been attempting to attract investment in housing through subsidies, benefits and tax concessions. How successful have these attempts been, the housing problem? Or,  in India and elsewhere,  have these attempts become so tangled and unwieldy,  that their original intent has been lost sight of? In this study, fiscal policies other  in attracting investment is  countries  in solving  examined.  The  to  the role of  the housing sector in  effectiveness  of  fiscal  India and  policies  in  increasing the amount of finance available for housing is examined. 1.2 Background a large portion of tax revenues is generated through indirect  In India, taxes  such  as  local  excise  (manufacturing)  regressive as they affect the poor more, the rich.  and  sales  tax.  These  taxes  are  who also pay them at the same rate as  As the poor tend to spend a greater percentage of their income on  basic goods,  they pay a larger percentage of their income as  as compared to the rich,  consumed,  taxes on goods  who with their higher propensity to save,  spend less and thus pay a smaller percentage of their income towards indirect taxes.  public  In a more equitable taxation system, revenues  through  progressive  income taxes and wealth taxes.  the emphasis should be on raising  taxes,  such  as  urban  property  taxes,  The incidence of these taxes rarely falls on  the urban poor as the basic exemption limits above which income and wealth are taxed,  are  fixed at a high level.  individual  investment  better-off  urban  improving through  the  in  the  dwellers,  housing  generation  of  Although the  housing  such  situation  sector  investment of  employment.  the  taxes  may  also  directly has  urban poor  Tax  designed to  policies  a  by  spillover raising  designed  investments in low-cost housing, whether by the employer, 3  affect  stimulate only effect  their to  the in  income  stimulate  or the state, or the  private sector indirectly benefit the urban poor. The  manner  in  which  public  revenues  are  spent  is  also  of  great  significance in improving the equity and efficiency of the urban system. For a more equitable urban growth, urban investment, pricing and regulation policies need to be designed to assist those forms of housing, and other  related services  that  population including the poor,  meet  of  the needs  a  sanitation,  transport  majority of  the  urban  and at costs they can afford.  1.3 Problem Statement The  post  capita income,  second  world war  era  has  seen  significant  increases  in per  life expectancy and literacy rates in most parts, of the world.  This is particularly evident in the developing countries when contrasted with the  earlier  era  of  almost  stagnant  growth.  The  rapid  economic  development  during the latter half of this century accompanied by political changes that led to a large number of countries gaining independence from their erstwhile colonial masters,  has led to a tendency for greater involvement of the State  in the welfare of its citizens.  In India,  which gained independence in 1947,  government has not only directly invested in certain priority sectors, but has also  used  areas.  fiscal  policies  to  try  to  private  attract  investment  Thus fiscal policy aim not only to raise revenue,  giving  tax  breaks,  encourage  investment  in  specific  but,  into  these  for example, by  industrial  sectors  or  geographical areas. Housing, environment  that  psychological world’s  conceived as a set of services, has  a profound  development  population  does  of not  impact  on  human-beings. have  adequate  insanitary and unhygienic conditions.  is an important aspect of the  the  socio-economic,  Yet  shelter  Housing is 4  a  sizable and  physical  fraction  lives  in  a global problem,  of  and the  extremely to which  even  the  developed  solution.  countries  have  not  been  able  to  find  The problem is more acute in developing countries,  population  lives  below  the  poverty  line,  and  the  low  an  acceptable  where a sizable  per  income  capita  precludes larger provision of housing and shelter by the government. The  housing  urban  situation  in  India  is  cause  for  especially in view of trends predicting rapid urbanization.  grave  concern  One of the major  constraints identified for urban development is the lack of adequate finance for  urban  economy  Since  . 6 shelter  is  has  concentrated  more  been  cent  and  of  agrarian,  concerned  resources  its  per  predominantly  still  government  73  the  population  it  is  about  policies  that  in  rural  and  the  surprising  that  the  development,  and  has  However,  the  not  rural  is  . 7 direction  importance of urban development has also been acknowledged in recognition of the fact that urban areas are the engines of development and the growing role of manufacturing and service sector in the economy.  The twin constraints of  low per capita income and large urban population make it imperative that the utility  of  scarce  resources  is  maximized.  For  that,  it  is  essential  that  comprehensive policies for mobilization and optimum utilization of both public and  private  are  finances  investment in housing, in  India.  8 billion  In was  required  The Planning Commission, 6 For example,  was to  estimated address  in 1991-92,  that  the  financial  a  housing  Rs.  3571 millions were In addition,  (Source: Government of India,  Planning Commission, 8  Due  to  inadequate  shortage  outlay of  an  of  Rs.  571.8  estimated  10  (1992).  41.8 millions spent on urban development. (both urban and rural).  implemented.  and  the backlog of housing shortage has continued to grow  it  1991,  formulated  (1992).  5  spent on rural development, Rs.  against Rs.  876.9 millions were spent on housing  (1993) pp 4-5).  million units in urban areas. efficient  An  housing  finance  system  based  on  the  principle  of  competitiveness, should be able to raise the bulk of its resource requirements by mobilization of household savings in competition with other participants in the market. countries,  It is difficult for the housing sector in India, to rely solely on the market determined system.  as in most other Thus,  government  intervention becomes necessary to ensure that adequate resources are mobilized to meet housing needs. Several  tax incentives and concessions have been given to  individuals  and companies for housing, but they are of a peripheral nature and their real value has fallen due to inflation. Also,  as the threshold above which incomes  and property values are subject to taxation are fixed at a high level , 9 many activities and sections of the population are  exempt  from income  less than one percent of the total population pays income tax. may be expected that,  any direct tax policies  and tax,  Therefore,  will only affect  it  the housing  investment decisions of people who pay tax and that these measures will not have any effect on the housing availability of the poorer sections.  However,  the rich do not build only for their own housing needs, and apart from renting housing  units  employees. housing  If  for  they the  also  provide  fiscal  a  policies  rental purposes  or  large are  proportion  designed  for employees,  to  of  housing  encourage  for  their  investment  they would go a  in  long way in  addressing the problem of housing shortage. Such policies can also be designed to attract investments in a government fund that  lndividual 9 capita  income  of  incomes Rs.  above Rs.35,000  10,000.  Also  as  are  subject  various  to  incomes  income are  tax,  exempt,  assessed to income tax out of a total population of 840 million  S  is used for giving housing  -  as only  that is,  compared to average per 8  million  persons  less than 1 percent.  are  loans to the lower income groups. Housing activity encouraged by fiscal policy measures would also have significant spillover effects, employment generation, The complex,  problem and  in  and would thus benefit the non-taxpayers indirectly.  of  urban  direct  the  population, investment  as  especially in terms of  taxes  impact  housing  housing  of  is  shortage  apply  only  fiscal  likely  to  policy  to  be  in  India  less  than  measures  limited.  In  is  very  one  per  cent  designed such  large  to  and  of  the  increase  conditions,  these  measures are likely to have only a moderate potential in addressing the issue of shortage of housing finance. 1.4 Objectives of the study The policies  objective and  of  the  instruments  study  on  is  to  housing  India and some other countries,  determine  finance,  by  the  influence  studying  the  of  fiscal  situation  in  and to attempt the formulation of a model for  India that shows how fiscal policy instruments can be used to increase housing finance. This is a theoretical and exploratory study, the  fiscal  policies  influence  the  amount  of  attempting to examine how  finance  invested  in  housing.  Fiscal policy measures that will increase the amount invested towards housing are  suggested. fiscal  through  The  study may  policies  the  lead amount  the  to of  formulation  finance  of  invested  a in  hypothesis housing  that  can  be  influenced. 1.5 Scope of the study This measures  on  thesis  is restricted to the study of  availability of  finance  influence of  for urban housing.  policies of the federal or central government, sector are studied. 7  fiscal policy  Only the  direct  tax  that are related to the housing  1.6 Methodology Can investment in urban housing be influenced through fiscal measures? n attempt is made to answer this question by examining the fiscal policies of some  countries,  such as Canada,  USA and UK,  to the extent  that  they affect  urban housing. These countries have been chosen, as they have made significant improvement in urban  housing.  This study utilizes secondary information.  Qualitative and quantitative  data from publications in the UBC library has been collected and studied so as to  gain  an  understanding  of  the  theoretical  influence of fiscal policies on housing finance, policies  Additional India  various  of  to  material study  incorporating  was  the  the  countries  and analyze  obtained  situation  fiscal  in  principles  their  policy measures  On  effect  the  that  the  and also to study the fiscal  through publications . 10 India  underlying  on housing the  of  basis  could  of  result  finance.  Government these,  a  of  model  in boosting  the  amount of finance invested in housing finance in India has been formulated. 1.7 Thesis Organization This  thesis  consists  of  eight  chapters.  Chapter  one  introduces  and  defines the problem selected to be studied and details the methodology of the study. gives  Chapter a  two  describes  descriptive analysis  reference  to  India.  the of  housing the  In Chapter four,  situation  in  system of housing the  India.  Chapter  finance  concept of government  for encouraging investment in desired sectors  is examined.  three  with special intervention  Special attention  is given to the theory regarding the use of tax expenditures  in the housing  The student has also drawn on personal experience gained as a bank officer in India, 10 in the taxation department of finance ministry of government of India, a student  officer  fiscal studies,  and as a resident of metropolitan cities of India.  8  an of  Chapter  sector. those seven,  in  certain  five  details  other  the  countries  housing are  tax  expenditures  described  in  Chapter  the effects of housing tax expenditures are analyzed.  concludes  the  study  and gives  policy  recommendations  expenditures in India.  9  in  India,  six.  In  while  Chapter  Chapter eight  regarding  housing  tax  CHAPTER TWO HOUSING SITUATION IN INDIA This developing  chapter  countries.  Highlights  India.  starts  of  The the  with next  a  discussion  section  policies  of  the  housing  situation  in  the  housing  situation  in  discusses  proposed  in  the  National  Housing  Policy  document of India are discussed in Section 2.3. 2.1 Housing in Developing countries Housing provision making.  of  shortages  a  housing  adequate  However,  are  problem presents  in a  almost  every  country,  challenge  for  government  and  the  policy  the severity of urban housing shortage varies from place to  place and it is generally observed that it is most severe in the big cities of developing countries. The  urbanization  process  socio-economic reality, resources, the  enormous  concentration  countries,  in  most  developing  countries  a  characterized by the mismatch between population and  disparity in the distribution of of  represents  population  in  cities.  In  income and wealth,  most  of  the  and  developing  the rate of urban population growth is high while the progress of  economy is relatively slow. This leads to differences in the labour supply and labour demand which in turn results in underemployment and unemployment. The disparity in the distribution of income and wealth is the underlying reason  for  income  in developing countries,  and wealth “absolute  Linn, 11  the  universal  result  in  . 11 poverty”  (1983)  existence  the  housing  problem.  Low  levels  and the disparity in distribution of  a much higher Under  of  these  proportion  of  circumstances,  p4.  10  the population it  is  difficult  of  income  living for  in the  developing countries to find sufficient resources to satisfy various needs of the population, The  including housing.  housing  problem  in  the  cities  rooted in socio-economic circumstances. combined  the  resources,  effect  and  distribution,  the  of  mis-match  disparity  addressed  be  in  and  of  developing  Therefore,  between the  reduced.  This  is  deeply  the solution requires that  the  social  countries  population  and  the  needs  to  and  spatial be  done  mobilized pattern  of  such  an  to  extent that even the poorest urban households can earn enough to satisfy their basic needs including housing. 2.2 Condition of Housing in India The condition of a country’s housing stock is a highly visible indicator of  the  quality  of  cannot  population  life afford  enjoyed even  by  its  basic  citizens. housing  The  from  majority  public sector or from private sources. of housing, from  other  prevents  own  their  resources, without external assistance by way of loans/grants,  sufficient  sectors  such  allocations  Indian  financial  either from the  Public sector institutions in the area  mostly depend on allocations from government budgets. priority  of  as for  agriculture,  industry  housing  the  in  Competition  and  defence,  national  budget.  Consequently a large part of the urban population is not adequately housed , 12 and  it  is  estimated that  9.55  million units  would be  required to meet  urban housing shortage projected for the Eighth Five-Year Plan period 1997)13.  Table 2.1 gives  the break-up of  the housing  during this period.  Sivashanmugam, 2  (1987)  me Economic Times, New Delhi. 3 ‘  (11th February,  11  1994) p.  17.  the  (1992-  requirements projected  Table 2.l-Pro:jections of Housing Requirements in India Number of Housing Units Required  Upgradation New stock: EWS LIG MIG HIG Total new stock needed Total housing requirement  Rural 4.07  Metro  6.45 1.34 0.25 0.10 8.15  1.18 1.04 0.31 0.22 2.75  12.2  2.75  Rental  housing  in  India  percentage of households in  Total Urban 1.75  Total 5.82  2.17  3.35  9.80  1.90 0.58 0.40  2.94 0.89 0.62  4.28 1.14 0.72  5.05  7.80  15.95  6.80  9.55  21.77  Economic Times; New Delni. (11th February 1994). Economically Weaker Sections Low Income Group Middle Income Group High Income Group  Source: The Notes: EWSLIGMIGHIG-  that  (in millions)  Other urban 1.75  -  (1992-1997)  rural  areas.  is  predominantly  an  urban  phenomenon,  living in rental housing in urban areas  During  the  period  1961-1981,  the  as  the  far exceeds  percentage  of  urban  households living in rented houses has shown a decline. Table 2.2:  Households living in rental housing in India  Rural Urban Total  1961  1971  1981*  6.39* 53.73% 14.80*  6.24* 52.88* 15.43%  6.97* 46.39* 16.48%  Source: National Institute of Urban Affairs, (1989a); p. *Does not include data for the states of Assam, Gujarat, Jammu and Kashmir and Nagaland; and the Union Territory of Delhi. The greater  advantages  flexibility  to and  the  tenant  mobility.  housing is a consumption expense, also  an  enjoys  investment. a  superior  house prices,  Ownership  status.  In  of  of  rental  However,  housing  all  the  are  money  zero  investment;  spent  on  rental  whereas expenditure on ownership housing is housing  India,  the  in  all  societies  expected high  rate  including of  India,  inflation  of  uncertainty relating to future levels of rent and to frequency  12  of movement,  the prevalence of practices such as  “pugree” or key money 14 make  ownership housing even more attractive. It is estimated that to house everybody, be produced every year, during the  . 15 eighties  3 million units are needed to  against the annual production of about 310,000 units The  sheer magnitude  of  the housing problem makes  necessary to have a phased program to eradicate this International  Year  of  Shelter  for  The  Homeless-  shortage.  the  In 1987-  Government  it The  India  of  resolved to provide a dwelling to each household in the country by the year 2000.  In this endeavour,  the thrust in the housing sector was proposed to come  primarily from the private sector. limited one, poor,  concentrating primarily on providing  including  the  economically weaker  dock and plantation workers. support  to  acquisition,  The role of the public sector was to be a  housing  boards,  The public  sections  subsidized housing (EWS),  dwellers,  sector would also provide  development  authorities  and development and housing construction,  middle-income groups.  slum  to  to  the and  financial  undertake  land  primarily for low- and  The private sector would have to play the major role in  augmenting the housing stock. National income accounts indicate that housing investment as a proportion of gross capital formation in the country has declined from about 30 percent in 1950 to only about 12 percent in 197516. Housing contributed 16.72 per cent  This 14  is the deposit tenants pay the landlord when renting premises.  from 3 months  rent to 3 years’  The Urban Institute, 15 Mohan, 16  (1982)  p1.  The amount may vary  rent.  (1989)  This is primarily due to the diversification of the economy,  investments in the industrial sector.  13  with large  to gross domestic capital formation in 1984-85 and 3.22 per cent to GNP . The 17 growth of gross capital stock in housing in terms of real value has only been about 1.5-1.6 per cent per year, over 2 per cent.  compared to the annual population growth of  Census data indicate that the quality of shelter per capita  has declined over the last 30 years, between  example,  1961  and  1971,  as measured by indices of crowding.  the  average  number  of  persons  per  For room  increased from about 2.6 to 2.818. Pbout 51.2 million people live in slums and squatter settlements and about 50 per cent of urban households live in crowded tenements.  one-room  There  has  been  a  30-50  cent  per  rise  in  the  prices in every major city of the country in the last two years . 19 of  urban  continue,  property  appreciating  faster  than  other  investments  property The trend  is  likely  to  as while the overall population is growing at the rate of 2.1 per  the population growth of urban areas is over 4 annually . 20  annum,  2.3 National Housing Policy The 199221,  Government  wherein  strategy  of  generation, economic  the and  government is  in  urban India, 17 (1982)  lndia Today, 19 Sivasankaram, 20  India  recognized  viewed  development.  concentration  Mohan 18  it  of  300  adopted that  for as  The cities  housing  the  an  its  growth  p1. 114.  (1991)  Government of India 2  part of  Housing  an  (1992a)  14  Policy  important  (NHP)  part  of  of  poverty  and  of  overall  improvement  urban  population  with a population exceeding  (July-December 1990) p 101.  (August 1993); p.  forms  alleviation  integral  rapid  National  100,000  in the  employment  and has  of its  led to  congestion informal  overcrowding  and  and  settlements  in  small  severe  houses,  pressure  on  steady civic  growth  services.  of  slums  This  has  and been  aggravated by institutional deficiencies of housing agencies and local bodies, and insufficient attention to the shelter needs of the poor. Chief among the goals proposed to be achieved in the NHP are, of  homelessness,  different  finance  to  central  and  municipal  and  state  provision  of  a  income groups.  government  taxation policy,  larger  For  would,  supply  developed  supply and management  among  other  including tax on vacant  curb speculative activities,  of  reduction  things,  of  use  urban land,  land  and  land,  the  fiscal  and  in order to  and to increase the supply of serviced land.  conservation of housing stock and rental housing,  For  the M{P envisages steps to  be taken by the central and state governments and financial institutions,  for  providing  fiscal  for  expansion  and  upgradation  of  NHP  recognizes  that  and  property  tax  incentives units  dwelling  and  financial for  and  proper  assistance maintenance  of  buildings. The  constructed by  the people  the  bulk  themselves  of  with  the  housing  their  own  in  the  resources.  country The  is  crucial  role of government at different levels is not to seek to build houses itself, but to make appropriate investments and create conditions where all may gain and secure adequate housing, and to remove impediments to housing activity. It is  envisaged  that  20  per  cent  of  the  requirement  investment  of  would be met by specialized housing finance institutions banking  sector,  provident  fund,  mutual  funds  etc.  (HFIs),  and  in  housing  insurance and  through  additional  mobilization of household savings. The objective of the NHP is to promote easy access  to finance for different housing activities and to evolve an elastic  and widespread resource mobilization strategy to tap household savings in the 15  formal  and  informal  sector.  Steps  would  also  be  taken  for  the  removal  of  constraints to the flow of finance into the housing sector. In the interest of long-term development of the mortgage market and to provide  assured  proportion  of  resources the  for  resources  the  of  housing  public  financial  channelled into housing with lending rates resources.  these  provident  fund  Apart  from  accumulations  diverting for  finance  system,  increasing  institutions  will  be  reflecting the average yields of increasing  housing  finance,  proportion  of  housing-linked  annual savings  for the workers in the organized sectors and public sector employees  schemes  will be introduced. It  is  envisaged that,  The National  Housing  Bank  (NHB-the  apex  agency  charged with linking the housing finance system with the financial sector as a will facilitate the promotion and regulation of HFIs in the public and  whole)  private sector,  refinance their operations,  and expand the spread of housing  finance to different income groups all over the country. The Housing and Urban Development increased  Corporation  for  meeting  (HUOCO)  requirements  groups in rural and urban areas, in  the  urban  institutions  areas.  in public  will  The  of  be  strengthened  providing  shelter  and  its  for  resources  lower  income  and for expanding infrastructure facilities  complementary  and private  roles  sector  of  different  concerned with  land  agencies  and  development,  house construction and finance will be supported. Innovative savings and lending institutions in public and private sector will be  introduced to  integrate the housing  finance system with the capital  market by enabling HFIs access to the funds on a competitive basis with other financial institutions and by permitting NHB and HUOCO to set up mutual funds for housing,  apart from their access to external aid. 16  Steps will be taken to  introduce a secondary mortgage system in order to attract funds range of investors,  including insurance and provident funds,  housing finance with the overall financial system.  from a wide  and to integrate  The long-term goal of The  National Housing Policy is that the housing finance system as a whole becomes self-financing. It should be able to meet the needs of different income groups and purposes, with longer repayment periods, graduated payments and simplified procedures; so as to ensure affordable installments and larger coverage across different urban and rural areas. The need to carefully target  capital  and interest  subsidies  for urban  and rural poor; and to make improvements in the housing finance procedures and shelter delivery system in order to bring down the poor  to  affordable  levels;  is  recognized  in  the  cost  of  NHP.  The  shelter for the housing  finance  system will be devised to respond on flexible terms to a variety of shelter needs of the rural and urban poor. The  need  to make  a  detailed assessment  of  the  role  informal  of  credit  network and community based savings systems for housing, and to devise ways of establishing its links with the formal credit institutions, access of the urban and rural poor to housing  finance,  cooperative  the  groups,  movement,  housing  especially  will be given assured access to  for  is acknowledged.  lower  institutional  so as to enhance  and  middle  finance to  The  income  supplement  internal resources. The NHP proposes to provide fiscal incentives to promote investment in housing  activity  additional  savings  by  the  private  sector  and  individuals,  for housing activity from households  and  to  channel  and enterprises.  To  induce employers in the organized sector to provide housing for their workers, tax incentives will be given for  investment 17  in rental or ownership housing,  for  especially  low  income  employees.  Similar  incentives  will  be  given  to  promote the building of new building materials and components produced out of and  industrial  agricultural  scarce  resources  steel.  The  like  levy of  wood,  stamp  wastes,  and  those  which  substitute  and energy intensive materials  duty and  registration  fees  will  like be  the  use  cement  of and  rationalized,  especially to reduce the financial burden for lower income groups. Government will  encourage  investments  housing  schemes  in  in residential property,  like speedy clearance by Central,  the  major  cities  to  channel  foreign  and would extend appropriate incentives  State and Local governments to stimulate a  sustained and large in-flow of such investment. Investment in rental housing, especially for the lower and middle income groups will be stimulated by encouraging individuals and groups to construct houses for full or partial letting by providing access to land, finance,  enabling regulations and incentives in central,  institutional  state and municipal  taxation of property and incomes. The  chief  constraints  in provision  dwellers are shortage of land,  of  adequate housing  and shortage of finance.  question of housing  shortage,  it  is  essential  to  examine  housing finance. This issue is examined in the next chapter.  18  all  urban  Though land is fixed  in supply, more land can be developed if finance is available. the  for  So,  to address  the  issue  of  CHAPTER THREE HOUSING FINANCE IN INDIA  In first.  chapter,  this  Section  3.2  the  basic  describes  followed by a discussion of  the  features housing  of  finance  constraints  the  housing  finance  system  to housing  in  are  examined  India.  finance  in  This  is  India  in  section 3.3. 3.1 Housing Finance  -  General  system  The basic proposition of the housing finance process is that a loan is required by most people buying a house  is  to purchase  probably the  22  a house  largest  single  This  is primarily because,  expenditure  incurred by most  and also because people buy houses when they are relatively young,  households,  when they have little savings of their own.  Hence they need to borrow.  There are four separate ways in which housing loans can be provided: 1.  The  simplest  way  is  the  direct  system,  through  which  loans  for  house  purchase are provided directly by the holders of financial assets, without the intermediation of  a  borrower and lender  financial  institution.  can never be  As  identical,  the  financial  the direct  requirements of  system can never be  fully efficient. 2.  In the contract system,  period  of  saving,  after  encourages  thrift,  and  rates.  This  system  potential house purchasers which  enables  is  used  are  they  people  to  extensively  eligible  acquire in  three  commit themselves to a  to  a  loan.  at  loans OECD  This  system  relatively cheap  countries:  France,  Austria and West Germany. 3.  The deposit taking system is the most common system.  Boleat, 22  (1986), pp 83-98.  19  Institutions,  such as  commercial  savings  banks,  banks,  cooperative  and mutual  banks,  that  in  the  course of their business raise deposits from the public, use these deposits to loans.  make housing  In a number of  taking institutions; New Zealand, 4.  e.g.  countries  there  are  specialist  building societies in Great Britain,  deposit  Australia,  and  and savings association and federal savings banks in the USA.  The mortgage bank system has the attraction of matching long term housing  loans with long term bond issues. fixed.  and bonds are  The  deposit  Continental  taking European  rates of interest on both loans  institutions operating the mortgage bank system do  not need a branch network, than  Generally,  and thus  institutions. countries,  their overhead expenses  This  system  especially  is  Italy,  are much lower  extensively  used  Sweden  and  in  the  Denmark.  The  mortgage bank system worked well when interest rates were relatively stable, but it has proved more problematic when interest rates have been variable . 23 Variable interest rates cause unseen fluctuations in the monthly mortgage to be paid, people  but  would  they are much fairer between consumers. prefer  to  continue  with  low  interest  If  interest rates  rate  loans,  but  rise when  interest rates fall people do not want to be committed to long term loans at high fixed rates.  It is difficult for consumers to forecast the future trend  of interest rates,  and time their purchases accordingly. With a fixed rate of  interest there may be people living alongside, mortgage rates.  Fixed rates of  people may defer or prepone expectation  of  fluctuations  in  23  Boleat,  interest the  housing  paying significantly different  interest are damaging to housing markets,  their decision to buy rates, market.  thus  (1986)  20  in accordance with their  amplifying  Variable  rates  as  the are  normal also  cyclical  beneficial  to  HFIs. Institutional funds for housing are provided in the following ways: 1. By direct lending to house buyers- the method used predominantly by banks, and some insurance companies. deposit taking institutions,  It is unattractive for institutions,  other than  to service and hold house purchase loans because  it is fairly labour-intensive and requires a branch network,  if economies of  scale are to be captured. 2. By direct loans to HFI5. 3. The institutional investors purchase marketable unsecured securities issued These give  by HFI5.  liquidity to the  institutional  investor while providing  the lender a steady source of funds for house purchase. 4.  Secondary mortgage  market,  which  originates and services a mortgage  is  huge  asset,  USA,  in  to sell  enables  it  the  HFI  that  to another institution  who holds the mortgage in its loan portfolio. The relationship between housing finance and the broader macroeconomic situation (1977)24  of  a  country  conclude  that  has new  been  extensively  housing  investment  debated. as  a  Burns  and  proportion  national product at first increases with the wealth of the country, decreases after a point. Buckley and Madhusudan  Grebler of  gross  and then  (1984)25 find that there is a  significant positive correlation between financial deepening and the level of housing  investment  across  their  sample  of  more  than  30  countries.  Malpezzi  (1990)26 also stresses the critical role of housing finance in the development  quoted in Hoffman et al, Hoffman et al, 25  (1991)  (1991); p.  33.  p 34.  p34.  21  strategy.  treating  By  investment,  planners  housing  more  as  a  consumption  fail to recognize its potential  good  than  as  an  for encouraging savings  and enhancing other sectors of the economy. House prices are capital, tax rate,  strongly influenced by the components of the cost of  such as the marginal tax rate of the market clearing buyer, before-tax nominal  expected  rate  property  tax  discount  house price  of  rates  and  rate,  appreciation.  reductions  in  mortgage Increases  marginal  in  tax  appreciation all lead to reductions in house prices. with the income tax bracket of the homeowner.  interest rate, financing rates  and  property and the rate  and  expected  These elasticities rise  The value of housing-  related  deductions and exclusions rises with the income tax bracket of the homeowner, which holding other factors constant, Boleat country’s also  (1986)  level  stresses  of  the  lowers the cost of capital . 27  has reported a significant positive correlation between a development importance  and  of  its  use  informal  of  financial  housing  finance  intermediation. and  savings,  He the  source of more than 80 per cent of housing investment in developing countries. Provision of housing finance is an important element of housing policies pursued by the governments of developed and developing countries of the world . 28 in the post world-war era component  of  development, benefits.  the  package  Investment of  in housing is viewed as a necessary  investments  for  promoting  as it does not merely create a shelter,  but also provides other  Increasing emphasis on more investment in housing is a direct of f  shoot of the welfare state goals of the modern governments.  Lea and Johnson, 27 Wood 28  socio-economic  (1984),  p 260.  (1986)  22  in both developed and developing  Housing The  financial  markets  in  housing  in  developed  better developed than in developing countries, Investment  infancy.  developing prices  and  countries  in  modern  is  inadequate  housing  construction  rising  countries  due  costs  stock to on  countries  under-invested.  are  comparatively  where they are still in their and  housing  low per one  is  capita  hand,  and  services income,  due  to  in  the  high land inadequate  financial assistance from their underdeveloped financial systems on the other. In  developing  countries,  access  to  housing  been limited to persons with higher incomes. prohibitive  income  and  underwriting standards,  down  payment  funds  lend  has  traditionally  The reasons for this may include  requirements  for  housing  to  meet  loan  a perception by lenders that lending to lower income  households is difficult and risky, limited  finance  only  to  the  or the fact that lending institutions with least  risky  borrowers.  Struyk  and  Turner  (1986)29 argue that expanding the population of borrowers is an integral part of  improving the living standards  informal  credit  programs  are  vital  in the developing world. in  providing  credit  least privileged citizens of developing countries, formal-sector lending process. access  to  formal  housing  Struyk and Turner  finance  leads  to  to  Quasi-formal and the  poorest  and  who are excluded from the (1986)30 have reported that  improved  housing  quality  and  infrastructure services in Philippines and Korea. A central  theme of much of  the more  recent  housing  finance research  concerns “Enabling Strategies” . Enabling requires that national governments, 31  A8 quoted in Hoffman (1990) p 51. 29 Ibid, p 54. 30 31 Hoffman,  (1991) p55.  23  rather than provide housing or subsidies directly, housing by liberalizing the market, and  integrating  housing  markets  building up  with  broader  facilitate the provision of  support  systems  capital  for housing,  markets  macro  and  economic policy. 3.2 Housing Finance in India TABLE 3.1: Housing Investment in India investment Total in Economy (Billion Rs.)  Plan Period  the  Investment in (Billion Rs.)  Public  private  total  public  1st1951-56 2nd1956-61  15.6  18.00  33.60  36.5  31.00  3rd1961-66  61.00  4th1969-74  housing  of housing invest ment to total invest in ment economy  total  2.5  privat e 9.0  11.5  34  67.50  3.00  10.00  13.00  10  43.00  104.0  4.25  11.25  15.5  15  136.55  69.8  226.4  6.25  21.75  28.00  12  5th1974- 79  314.0  161.61  475.6  10.44  36.36  46.80  10  6th1980- 85  975.0  747.10  1722.1  14.91  115.0  129.9  7.5  7th1985- 90  1681.5  1800.00  3491.48  24.58  290.0  314.5  9  77.50  697.46  774.96  8th1992-97 (propose  —  d)  Source: Urban India: (July- Dec. 1990). p .25. Note: In general all plans are for five years. However, there were plans from 1966-1969, and 2 annual plans in 1990 and 1991.  3  annual  There has been a steady increase in the quantum of housing investment in India,  since  1950  (Table  3.1)  .  However,  in  percentage  terms,  the  share  of  housing investment to the total investment in the economy has been declining, from 34 per cent in the first Five-Year plan  24  (1951-56)  to 7.5 per cent in the  sixth plan period has  While the private  (1980-85).  declined from 50%  in  1950  to  16%  in  sector  1990,  the  investment  share  in housing  for public  sector  investment has gone down from 16% to 1.4%. This decline is due to reduction in the share of investment in housing relative to investment in other sectors. The  Indian housing finance sector has two distinct sectors-  informal. like  formal and  The formal sector includes specialized housing finance institutions  the  Housing  Development societies  and  and Finance  and  the  Urban  Development  Corporation  state  housing  (HDFC),  Corporation the  cooperative housing  boards/development  authorities,  general investment institutions like the Life Insurance Corporation General  Insurance  commercial banks. is  Corporation  (GIC),  Trust  of  India  and housing  finance  is  their main beneficiaries, a  supplementary  search for alternative investment opportunities.  effort,  whose  finance  and  also  (LIC), the  (UTI)  The primary function of the general financial  to protect the interests of  command,  the Unit  Housing  (HUDCO),  and the  institutions savings  they  triggered by their  They also invest in housing  to fulfill national commitments to social-oriented sectors . 32 The countries.  informal  housing  In India,  finance market  is  quite unique to the developing  it is also the more important component.  indigenous money lenders  and bankers,  friends,  It includes the  relatives and employers,  who  supplement the personal resource mobilization efforts of the individual home owner- who may also utilize his cash savings in addition to what he can raise through liquidation of self-acquired or inherited assets. Over  three-fourths  sector in India is  La11, 32  of  the  annual  financial  from the informal sector,  (1985>  25  investment  in  the  housing  while only 22.6 per cent comes  from  formal  the  financing  institutions.  The  central  and  state  governments  provide a substantial proportion of the finance through budgetary allocations. The  of  contribution  increasing, societies.  specialized  financial  institutions  with the spread of activities of HTJDCO,  has  been  gradually  HDFC and the cooperative  There has also been some increase in the investment flows through fund organizations,  the provident  but the relative contributions in terms of  total financing have not improved in the case of the commercial banks, GIC and LIC  to  any  institutions  noticeable is  not  extent.  The  substantial  overall  role  enough to make  a  of  specialized  discernible  financial  impact  on  the  role of the informal housing finance market . 33 The housing capital  national  finance market has market.  availability of a mass  This  level  is  due  relatively little to  several  institutional  interaction with the  factors,  such  as  framework to mobilize  the  non—  savings at  competitive rates of interest, the need of housing sector for long-term credit whereas  the  capital  availability of  market  may  supply  attractive salable  mainly  financial  short-term  assets  funds,  the  from the housing  non-  sector  and the general disinclination of commercial banks to finance housing activity as a normal business operation. Another important characteristic of the formal housing  finance market  public sector,  is  the dependence of  specialized institutions on the  either the central or state government and LIC and GIC.  These  institutions have had little success in tapping household savings. In the informal housing finance market,  the most important supplier of  finance is the extended family of the home owner. The home owner mobilizes his  own resources from his savings,  La11, 33  as well as  (1985)  26  liquidation of assets.  Relatives  and friends also provide substantial support. The indigenous bankers and money lenders play a very crucial role in the case of people in low income groups, residents of  smaller cities and persons with casual or seasonal  the  housing sector  informal  (including  slums  and squatter  incomes.  settlements),  In the  role of indigenous money lenders is significant. finance  Housing  for  the  middle-  and  high-income-groups  provided  is  mostly by the private sector and also by HTJDCO and HDFC at the national level, and by housing boards and development authorities at the state groups  also have  access  to  finance provided by their  banks and insurance companies. groups  been  have  forming  In larger cities, housing  group  level.  employers,  These  commercial  the members of these income  cooperative  societies,  collectively bargain for allotment of serviced land and finance.  which  The bulk of  finance is generally obtained from the HFIs and allocated to individual house builders.  There  Benefits  of  materials. dissolved,  is combined preparation of plans  economies Even  but  of  after takes  scale  completion  over  the  availed  are of  have  been  very  functions  successful  the  construction, of  housing stock and public areas of the colony. societies  in  for the layout and houses.  in  repair  purchase the  and  building  of  society  is  maintenance  of  not the  These cooperative group housing  the  metropolitan  towns  and  are  encouraged by the Government as they bring about augmentation of housing stock in a planned and legal manner. by 1991, to its  In India there were 60,000 housing cooperatives  with over 4 million members . 34  credit over  invested Rs.  40  The Cooperative Housing Movement has  1 million constructed houses.  The  cooperative sector has  billion in the housing sector and every year Rs.  Government of India, 34  (1992)11  27  6  billion  more  are  added.  About  60  per  cent  of  housing  finance  disbursed  by  apex  cooperatives has gone to economically weaker sections and lower income groups. As  part  of  the  allotment  land  policy,  government  gives  preference  to  cooperatives in the allotment of land. Even for the middle-  and high-income groups,  housing finance comes through informal channels. and borrowings  family,  from  friends  and  a  significant portion of  Apart from personal  relatives,  an  indigenous  raising large amounts of interest free loans has been developed. chit  fund system . 35  purpose  of  finances,  raising  is  savings  system of  This is the  The operation of chit funds is not confined only to the finance  for  used extensively,  shelter.  but not  The  chit  fund  exclusively,  of  system  raising  by the poorer sections,  who vary it in terms of frequency and amounts, to suit their needs. The prevalence of chit fund and other informal means of raising housing finance, of  even among the better-off people,  finance,  two  illustrates  points.  still undeveloped and rudimentary, society have  to  resort  sector perpetuates  A number 35 amount of money.  of  the  persons-  friends,  sector-  relatives,  This  financial  which  colleagues  deficiency of  in turn  and  even  This procedure is repeated every month,  without going to a bank or institution,  system  is  free loans.  where apart  finance  the  results  neighbours  in a  large  the  pool  same  whose name is  for as many months as there in the  after the chits on which each member’s name is written.  members of a fund have access to interest and forms,  formal  so even the more affluent sections of the  informal methods.  extralegal  the  and each month another member is allotted the total amount  known as chit fund,  fund-  which is  In this manner the  They are also able to save a target sum  from feeling intimidated by the procedures  they will also be required to produce collateral or security and will have to sign a statements and pledges.  number of  First,  The total amount so collected is given to a member of the group,  picked up by draw of lots. are members,  to  who have access to formal avenues  The chit  fund system operates  in an informal manner and all  transactions are verbal and without any tedious book-keeping. The system operates on the basis of trust  and  defaults  friendship  are  where  an  occasional  default  addressed through peer pressure-  is  covered  from relatives,  up  by  friends.  and neighbourhood. A chit fund may operate with installments of any amount.  28  More  friends and seniors  persistent  in workplace  parallel  economy.  The  second  point  investment required for shelter is explored  exhausted  and  committed.  a  is  that,  the  volume  so large that all avenues of finance are  large  locality of Delhi  salary for eight years . 36  of  portion  future  earnings  is  is worked out at a total  Considering that an average household has  that all the savings of the household for 32 years  and marriage of it  poorer  so  children.  the  difficult  sections,  who  to  have  can  It  stands  housing  afford  to  to  of  it means  (almost the entire working  are required to provide for a house of its own.  a house leaves little for other major expenses,  find  also  of a person’s  only one salary-earner and can save upto a maximum of 25 per cent,  tenure)  of  The relative quantum of investment required for a three-room house  in a middle class average  and  illustrated  This large outlay for  such as illness or education  reason  their  that when the better-off  own,  the  spend only about  situation  5-10  for  percent  the  their  of  earnings towards provision of housing is even more grim. The adequate  very high financing  of  cost for  housing  expanding  units  the  additional burden on low-income-groups.  and  supply  the  of  difficulty  low-priced  in  obtaining  housing  places  The poor are generally excluded from  conventional financing schemes due to high interest rates and restrictive loan terms.  Moreover,  income-groups benefits  of  efforts  the  have  rarely  conventional  income groups because  of  the government  reached  the  solutions  are  to provide  targeted absorbed  housing  population. by  the  upper-  for  low-  Instead,  the  middle  and  of high housing and infrastructure standards  that the  poor cannot afford. A sizable  Pugh, 36  proportion  of  the  urban poor  (1990)  29  in  India  are  employed  in  the  informal sector. the formal policies  This  sector,  are  developmental institutions  informal  sector provides cheap labour and products for  for whose promotion and expansion most of  geared.  As  system,  the  conventional  unable  are  informal  to  address  sector  is  kept  construction the  needs  impoverished  and  of  the government  this  in  the  housing  financial  sector.  Therefore  alternative non-conventional strategies are needed to help supply the housing requirements of this segment. Explicit policies and mechanisms are required to be created for the lower-income groups employed in the informal sector, as the policies for the rest of the population cannot meet their different needs. These  policies  have  recognize  to  the  strengths  poorer sections whom they are meant to benefit.  and  abilities  of  the  Generally it is assumed that  the poor are so poor that they are unable to save anything. But it is reported by UN  (1978)  that despite very low incomes,  they can achieve an unexpectedly  high rate of saving when a strongly desired item is seen to be accessible and can be purchased in small and easy installments. This observation is supported by  Sivashanmugam  (earning Rs.  (1987)  who  has  700 or less p.m.),  while in the next income group  reported  that  in  the  lowest  income  group  43 per cent of the households save regularly; (earning Rs.  701-1500 p.m.),  85 percent of the  households save regularly. To encourage savings among the poor for housing,  it has been suggested 37  that there should be deposit insurance and indexation of savings for housing of the poor from inflation. tried banks,  successfully trust  funds  united Nations, 37  in and  Preferential tax rates for such savings have been  Korea  and  insurance  Indonesia.  The  companies not  (1978)  30  involvement  of  currently engaged  commercial in direct  mortgages  lending  for  finance  institutions  is  likely  to  increase  competition  and could lead to better  terms  for  among their  poor show exceptional ability to mobilize indigenous resources.  housing  clients.  The  They salvage  old and non-conventional building materials from demolition sites and  waste,  They are able to construct dwellings at costs much lower than  garbage dumps. any  the  system  public  of  sector  construction,  yet  their  investments  are  substantial both in aggregate as well as for each household. A survey of Poona 38 indicates that the best shanty dwellings slums comparable to,  (constructed by the poor)  are  or are better than any public sector provided EWS housing,  and  2000 on average in contrast to Rs. 8000-10,000 cost that is  cost just over Rs.  the minimum rate that the public sector can provide at. 1n important role is played by HUDCO for meeting the housing needs of the poor. since  It has financed over 2.6 million dwelling units in the urban areas  1960,  and  of  these  90  per  cent  have  gone  to  poorer  and  vulnerable  groups. For meeting the needs of housing finance in India, Bank  (NHB)  was  established  number of schemes,  such as,  in  1988.  It  is  providing  Home Loan Account Scheme,  the  National Housing  assistance  through  a  liberalized lending by  commercial banks and refinance facilities. Refinance for land development and shelter  programs  of  public/private  agencies  and  cooperatives  in  order  to  increase the supply of serviced land has been undertaken. By the end of 1991, the  NHB  had advanced  refinance  amounting  to  over  Rs.  7  billion  to various  commercial banks and other housing finance institutions and cooperatives. Over half-a-million accounts have been opened under the Home Loan Account scheme,  (1982)  31  mobilizing household savings to the tune of almost one billion rupees of India,  1992)  Apart from the creation of the NHB, involved substantially in housing fixed  (Govt.  for  the  housing  loans  the banking sector in India has been  finance.  advanced  Revised  by  the  interest  commercial  rates  banks  have been  and  housing  finance institutions. Another  source  of  formal  housing  finance  is  housing  loans  from  employers. These are provided by all the public sector employers; and by large private sector firms. However, quite  low,  as  it  is  the incidence of this type of formal finance is  restricted only to the  small  section of  the population  that is employed in the formal sector- thereby excluding not only the persons employed in the informal sector and by small private firms, but also the selfemployed and the unemployed. Even the persons who are eligible for these loans have to wait a considerable period before they are eligible for the loan and also due to the limited amount of funds available for such loans. useful  to  examine policies  that  would encourage  more  firms  It would be  to give  housing  loans to their employees. 3.3 Constraints for Housing Finance By  developing  country  standards,  the  sophisticated and large relative to the GDP. is  high,  averaging 22  per  cent  in the  Indian  financial  Furthermore,  l980s.  The  system  monolithic,  Only  Buckley et al, 39  a  few  (1989)  financial  depth and breadth of  32  the  even those  the Indian financial system is also  institutions  p19.  both  the rate of saving  Indian financial system exceeds that of most developing countries, that are more developed than India . But, 39  is  have  access  to  most  of  the  country’s  financial  institutions  These  They  other.  act  resources, are  and most  highly  regulated  instruments  as  of  of  these are government  and  tend not  government  to  controlled.  compete  investment  each  with  policy  as  they  allocate resources according to government directives, rather than in response to market incentives. The  constraint  key  in  housing  investment  has  been  the  lack  of  an  organized system of housing finance on a large scale as only a few agencies provide  finance  housing.  for  Only  employees  in  the  organized  sector  have  access to such finance, not the self-employed and others outside the organized sector.  Considering  that  not  persons  employed  sizable portion of the urban population, of  system  housing  finance  is  it  in  is  established.  the  formal  sector  form a  imperative that a widespread  The  aim  should  be  to  provide  institutions at the local level where an individual can go to obtain mortgage financing at reasonable rates for a long term. To fulfill this aim despite the problem of availability of long term finance, Mohan there  should  simultaneous  be  Institutions,  Mortgage  institutions.  The  banks  are  schemes,  Insurance  local  required  formation  to  level  housing  mobilize  local  finance  savings  Apex  of  system and  for  (1982)  has suggested that  Housing level  inst—i-tutions  housing  by  Refinancing  housing  finance  such  housing  offering  as  attractive  and then ploughing these savings back into the community in the form  of housing loans and mortgages.  The Apex Housing Refinancing Institutions are  needed to refinance the mortgages for which the funds can be raised from long term sources of finance, to  provide  marketable.  mortgage  such as LIC,  insurance  GIC,  systems  provident fund etc. to  make  the  There is need  mortgages  safe  and  There has been some progress in India in establishing local level  housing finance institutions through the formation of National Housing Bank, 33  but without the other two institutions it has a limited impact on the overall housing finance situation in the country. The  small  amount  of  housing  investments  made  by  formal  FIs  can  be  explained by the fact that very few assets are involved. The more developed an economy is,  the greater is the extent of financial intermediation.  In the case  of  investment  numbers  housing  in  small loans are involved, short-term  deposits  are  developing  relatively large  countries,  raising transaction costs. transformed  Severe problems arise if  long-term  into  loans.  inflation makes lending for housing production unattractive, exists a lack of confidence in young FIs.  the  commercial  investment, Apart also  have  i.e.  amounts  high  and there often  in India.  of  to hardly 10%  the  The contribution  institutional  housing  less than 1% of the total market.  from addressing resource constraint, to  production.  banks  Recurring  These factors explain the very low  institutional participation in housing investment of  of  be  adopted  to  improve  Guarantee of tenure,  the  contemporary policies might for  scope  an  increase  in  housing  would not only stimulate low-income families  to improve their dwellings but would also increase their chances of obtaining access  to  the  existing  financial  and  mortgage  voluntary associations and building societies,  . 40 systems  The  formation  of  in which the participant low  income families could unite, with the aim of increasing their credibility with existing  financial  systems  and  a  transfer  of  land  rights,  would  also  be  beneficial. A further relaxation of building codes and a more efficient supply of building materials  Such loans are 40  (cement,  steel and timber)  cheaper than loans  bankers who charge usurious rates of  raised through the  interest.  Also,  cash savings.  34  would deflate housing costs.  informal  sector,  mainly indigenous  their savings would earn interest,  unlike  A better  environmental  infrastructure  and sewage connections); building  technology  (roads,  drainage,  levelling  and water  and further development and application of low-cost  for  housing  construction;  would  go  a  long  way  in  stimulating housing construction. Housing finance and land policy are the two major areas in need of the attention of policy makers in the economics of housing reform . 41 progress  in housing finance can lead to increased supplies of housing,  possibilities income price  Reforms and  of  groups.  extending housing  However,  inflation.  One  housing  key  wealth  finance  consequence  and welfare  can  of  also  this  is  to moderate and  lead  to  that  housing  low-income  and  with lowland  access  to  housing is impeded, and housing resources are diverted to the upper and richer end of the housing market. Housing systems in developing countries are inequitable, prior  inequality in the ownership of  production-consumption economy. is  intense because  supply falls  has  three  clear  short of demand.  purposes  housing  across  a  wide  Second, range  in  such  of  Pugh,  a  This  results  in insanitary  . 42 context  First,  the  income  especially in the informal sector,  distribution  low-income households will be bought  42  in the  it becomes a priority to increase the supply of  higher percentile ranges are not increased,  Pugh, 41  from work  From the reformist perspective the housing  generating potential for the total economy, has key significance.  and earnings  Competition for housing and good street space  slums or living on the pavements. policy  capital  reflecting the  of  income.  If  supplies  (1990)  35  the  then some housing provisions for  from them by the more affluent.  (1990)  to  Third,  specific policies to improve the housing welfare of low-income households are needed. Urban  development  creates  economic and social value.  assets  which  in  total  represent  enormous  There is potential to add to urban investment,  and  to use housing policy as a means of extending property rights in assets.  The  further down the profile of income distribution that asset value in land and housing  extended,  is  the more  will  policy be  redistributional  in  favour of  moderate and low-income households. To spread the extent of owner-occupied housing and land,  housing and  land policies have to be coordinated to ensure that land price escalation is curbed.  ineffective  If  availability  of  land  housing  policies,  capital  and  land  will  be  trickled  favouring the wealthy will push up operate  efficiently when  inflation,  low  Housing  production  that  employment, time  interest  resources  in  housing  and  restricted  will  mainly  In these circumstances supplies of new out  at  low  levels.  Strong  land and building costs.  are  rates,  land,  of  high  rates  and  competition  competition  Housing markets  employment,  low  among  rates  builders  of  and  43  financiers  benefits  there  in  occur,  concentrate with upper income groups. housing  speculation  lost  spread  has  into  its the  it upgrades skills, from  sickness,  it  economic general  costs  but  economy.  it  It  also  adds  to  has  economic  income  and  it reduces social costs such as the value of motivates  savings  and  it  general economic and social development of the society.  contributes  to  the  It is estimated that  an investment of Rupees ten millions in housing would yield employment for 670  Pugh,  (1990)  36  man years  44  On the demand side of the housing market,  such things as the willingness  to pay and the choice of priorities among food,  housing,  and other things are  readily expressed. But in many crucial parts of markets and production, is  adequately forthcoming.  not  insufficiency mortgage  and  of  building  credit  In India,  materials,  markets,  and  the bottlenecks  blocked  access  to  to  arise,  because  rents  are  continuously low additions  controlled  influence many building materials. development  supply include,  land,  Land price inflation is also evident and problematic.  stock.  and  government  supply  inadequate  to  the  housing  Further problems  regulations  on  prices  Rent controls and regulations lead to the  of black markets and black economy.  Rent  controls undermine the  long term supply of private rental housing. The rate of development in public rental housing does not fulfill the demand and need for rental housing. Savings and  the  credit,  towards housing investment  development  of  the potential  instruments,  leading  housing  credit  can be  induced with tax  institutions.  By  demand is brought within affordable to  expanded  production  and  incentives  enlarging  housing  loan and mortgage  competition  among  housing  firms. Housing markets and housing sector become better organized. In the context of low income housing,  the question of affordibility in  the provision of adequate housing becomes a key issue for both the private and public sectors. of  the  income;  In the past, either  for  Affordability varies greatly,  urban India, 44 pugh,  as a rule of thumb affordibility was taken at 20% rent  or  for  repaying  installments  on  . 45 loans  especially with regard to the amount of saving  (July-December 1990) p102.  (1990> p77.  37  in the household and in how their housing expenditure varies when their income increases. As  is  housing  responsiveness evidence  a  when  basic  income  developing  from  elasticity of demand.  need,  economists  increases. countries  However,  would  (1985)46  Malpezzi shows  expect  that  low  has  housing  degrees  reported  has  low  of  that  income  housing does absorb some share of increase in  income over the medium and longer terms, providing there is some perception of improvement affordable  in  housing  conditions.  it  upgrade  loans,  can  If  a  household  housing  its  can  standard  have and  access  pay  for  to the  continuation of these standards over the duration of the loan and beyond. With useful  and effective  initiatives  in public policy,  and investments can be used to enlarge the volume of resources  some  savings  that go into  housing. Housing finance is the key link in the potential for transforming the housing masses.  and  urban  social  investments  into  property  and  benefits  for  the  This is not inevitable as it would not materialize if flows of saving  coming from the general community are channelled into higher-income housing. The process to assist a wider range of income groups,  depends upon the terms  and conditions built into the design of housing credit. Typically formal HFIs provide less than 20% of the annual investment in housing.  Most  of  that  investment  is  channelled to  upper ranges of middle income groups. markets finance. and  grow and become But,  economic  more  higher  income  As an economy modernizes,  specialized,  with  some  groups  and  its capital  development  in housing  housing and non-housing capital have distinctly different needs forces.  As Quoted in Pugh 46  Generally,  (1990)  p.  housing  77.  38  requires  longer  term  finance  than  industry.  It  also  functions  best  when  placed  on  a  revolving  basis  so  that  flows of borrowing and lending are continuous, providing the capacity to grow. The efficiency of saving institutions is important, of  down.  borrowing  households  But  in  a  developing  because it keeps the cost  country  and tapping their saving potential  the  costs  of  can be considerable.  reaching It may be  necessary to establish a network of localized branches and to deploy outreach programs in order to induce the savings habit. schemes  are  required  among  low-income  Innovative and flexible savings  households,  so  as  to  adapt  to  the  irregular and intermittent nature of their income. -.-  3.2  v”  “  ---  Public sector*  Plan period  1950-51 First Plan 1951-56 Second Plan 1956-61 Third Plan 1961-66 Annual Plans 1966-69 Fourth Plan 1969-74 Fifth Plan 1974-79 Sixth Plan 1980-85 Seventh Plan 1985-90 (target 1984-85 at prices)  *  Tri,H  ‘  Private, corporate and co operative sectors * 0.9 1.0 1.3 1.8 1.3  1.8 1.7 2.1 3.4 2.4 2.9 4.7 4.0  Household sector*  Total*  7.5 7.7 9.0 9.1 11.0 12.8 15.6  10.2 10.4 12.4 14.3 14.7 17.4 21.9  16.7 17.0  22.5 23.7  1.7 1.6 1.8 2.2  4.5  Source: Sivashanmugam (1987) p 74. As a percentage of GDP at current values  As Table 3.2 depicts, community.  Households  as  there is a great savings potential in the general a  whole  are  net  savers  in  the  economy.  The  development of capital markets can be hastened by using housing as a means and as a motivator.  39  in  Mulkhraj  l98O’  reported  that  when  home  ownership  obligations were taken up by moderate-income families; the patterns of income and consumption. supplementary or overtime work. is  pressed  down,  but  it  there were changes in  In the first years of repayment,  becomes  mortgage  Income tended to increase, mainly from  more  efficient  expenditure on children’s education,  avoided,  and  and  consumption  productive.  Waste  is  clothing of women and children  increases; as the family feels a status and situational change. The development of housing credit has problems to overcome. market,  a number of dimensions and some  The FIs will be exposed to competition in the capital  where they lend for the long term but borrow within the confines of competitive  intensely  short-term  conditions.  changes in the rates of interest, economic management, the flow of funds. defaults,  The  realities  of  competition,  and the general performance in the national  with its impacts on inflation and employment,  The institutions have operating risks,  such as,  can affect borrower’s  collapse of market in a recession, and intensive competition for the  deployment of savings. Risks can be moderated, borrowers can be constrained to higher  pay  proportion  of  their  own savings  higher standards of collateral can be imposed, made  more  groups.  restrictive.  All  these  reduce  It is these very conditions,  in  deposits  for  home  purchase,  and income eligibilities can be  access  to  moderate  and  low  along with limited flow of funds,  income which  create a situation where formal housing credit serves only the borrowing needs of  the higher  income groups  in the  developing countries.  This  can become a  problem for all income groups because housing credit expansion that is tied to the upper end of the housing market can inflate housing and land prices  Pugh,  (1990)  40  for  all groups.  Competitive pressures drive up prices and steer resources to the  upper end of the market. Developers  often find that capital  is not  finance the building and marketing process.  always  readily available to  In developing countries this often  means that projects will be commissioned only when the ultimate consumers, household, this, can  have made their arrangements to obtain credit and to so organize  that it finances the building process. their production and  finance  product.  the  But,  the process  is  reduce  restrictive  the  In this way private developers risk  failing  of  and cumbersome.  to  sell  their  Housing would flow  more rapidly if developers learnt how to interpret market preferences and lead the  market.  possible  if  development wider  range  would mean  It  finance were  that  available  construction  and  of  opportunities  of  they  took  from the  housing.  in  more  the  It  of  the  risk,  capital market should  housing  be  and  to  resource  possible  market,  would be  serve  to  including  the  sites  a  and  services schemes, which need not be provided by the government only but can be privately organized or be planned and executed under joint venture schemes. Housing credit and mortgages connect the supply of housing to the demand of households.  Accessibility to  credit  and installment purchase becomes  important. This accessibility depends upon the duration of the loan, of  rate  of  interest,  and the  amount  of  deposit  that  is  all  the level  required as  a down  payment. Banks and building societies 48 establish their loans on the basis of their supply of funds, of  the property  or  a  the income level of applicants, collateral  asset  value  in  the  and the secured value borrower’s  standing  in  The building society movement is non-existent or undeveloped in most of the developing 48 countries. The building society movement began in Britain. In the earlier years of the industrial revolution, some skilled workers created small scale savings funds so that members could borrow in times of need. From these funds came some housing allocations for home ownership.  41  In the developing countries,  owning wealth. mutual  savings  funds  and  there  are  money  the banking sector often has some lenders  who  charge  high  rates  of  interest. Formal sector housing finance serves mainly the high- and middle-income groups. HFIs.  Loans are available from cooperative societies and a few specialized  Typically the  loan meets  only about  47  per  cent  of  the price  of  the  dwelling. The price of a typical dwelling is about 8 times the value of annual household income of the borrower.  The average income among borrowers is about  Rs 33,000 per annum, and this compares with low-income families who have about 8,400 at the top of their range, finance  is not  and about Rs 4,000 near the bottom . 49  affordable to the masses,  and even  Such  for the more affluent  it  does not flow in significant volumes to meet all the demands. Existing HFIs  overlook the household sector  . 50 per cent of total domestic savings  that  contributes about  These formal agencies depend on either  budget allocations or borrowings from other financial institutions UTI  and  commercial  resulting This  which  banks)  in  74  turn  mobilize  the  (LIC,  household  GIC,  savings,  in multifinancial transfers in the housing finance intermediation.  results  in  increased  cost  of  finance  to  the  ultimate  beneficiaries;  irregular supply of funds to the housing agencies and over dependence on other financial  agencies.  The  savings  instruments  compatible with household characteristics. hypothesis  that  creation  of  appropriate  used  by  the  Sivashanmugam has put institutions  and  (1990)  sivashanmugam, 50  (1987)  42  are  not  forward the  instruments  bring the household savings into housing finance intermediation.  pugh,  HFIs  will  As per the National Building Organization 51 the total backlog of housing is estimated at 31 million in 1991- of which 10.4 million is in urban areas. Rs.  571.8 billion are required to meet this shortfall of urban housing.  More  than 80 per cent of housing finance comes from private savings and non formal sources of credit. Housing finance institutions would be required to mobilize household savings  through operations of innovative saving programs including  those linked to credit for housing and the capital market  in order to raise  high volume resources through a combination of cost effective debt and equity instruments. The role of formal finance in terms of the volume of housing finance, is larger than the general perception,  but its role in terms of the number of  borrowers it assists is small . Existing lending procedures are too rigid to 52 allow small borrowers to take advantage of the liberal terms and conditions at which the formal institutional sources extend housing finance. Loan to housing cost  ratios  are  extremely  and  low,  these  result  in  poor  quality  of  construction. Public investments in housing are extremely low in India, accounting for only  l.5  provides  only  provided  by  . 53 sources  total  of  20-25 the  development  assistance.  the  housing  of  household  total sector-  Public,  institutional  investments,  household  and  other  while  the  sector rest  is  non-institutional  The informal sources of finance, which are mostly used by the poor  are generally more expensive. There exists a dualistic housing finance market,  As quoted in The Planning Commission (1992). 51 National Institute of Urban Affairs, 52 Ibid, p 53  (1992) p  (xi)  43  (ii)  wherein there is a very high degree of dependence by the poor and low income households on own savings and informal, savings  and  formal  and  institutional  non-institutional sources, sources  relatively  by  high  and on own and middle  income group of households. Table 3.3:  Sources of Housing Finance in India % of households  Magnitude of (million Rs.)  14.8 24.2  Savings a. Savings b. Formal credit  40.5  a. b. a. b. c. a. b. c. d.  Source of finance Savings only credit & Formal Savings credit Informal & Savings credit, Formal Informal credit & Savings  100.0  ALL  Source  20.5  :  Savings Informal credit Savings Formal credit Informal credit 72.58 Savings Formal 44.00 Informal 15.53 132.11 TOTAL  National Institute of Urban Affairs  Table 3.4:  investment  (1992)  by  source  10.25 22.09 25.06 14.61 6.13 25.64 18.93 9.40 (54.9%) (33.3%) (11.8%) (100.0%)  p 9.  Share of Various Sources of Housing Finance in India Percentage share  Source of finance FORMAL SOURCES a. Provident fund and employer b. Banks and others c. Specialized HF agencies INFORMAL SOURCES a. Savings i. Cash savings ii. liquidation of assets Loans from friends & relatives b. c. Loans from indigenous bankers TOTAL INVESTMENT IN HOUSING FINANCE Source: National Institute of Urban Affairs Tables  3.3  and  3.4  give  the  33.3 10.9 10.3 12.1 66.7 54.9 33.8 21.1 9.9 1.9 100.0 (1992)  details  of  p 11. various  sources  of  housing  finance as reported in a survey conducted by the National Institute of Urban Affairs(1992)  in certain cities of  India.  This  survey shows that  the  households generally used more than one source of finance for housing.  44  sampled Formal  sources  of  finance were used more by  groups. However, Housing  households  belonging to upper income  they also used informal sources.  finance  is  one  of  the key determinants  of housing.  huge shortfall of both urban and rural housing in India, increase the available amount of housing  finance.  constitutes only about one-third of the total, fraction of highersections  are  left  As  it is imperative to  formal  housing finance  and that also benefits a small  and middle-income sections of the population, to  finance  which is more expensive.  Given the  their housing needs  through  the poorer  informal  finance,  In the next chapter the issue of how fiscal policies  can increase the amount of formal housing finance,  45  is examined.  CHAPTER FOUR  FISCAL POLICIES RELATING TO HOUSING chapter  This housing.  The  taxation  and  contains  introduction fiscal  a  discussion  in section 4.1  policy  measures  to  fiscal  of  policies  details  as  achieve  public  relating  to  to how governments use policy  objectives.  Section 4.2 examines the reasons as to why governments intervene in housing, while  section  Section  4.4  4.3  gives  defines  the  the term  problems  associated  “tax expenditures”.  with  The ways  enters the tax system are discussed in section 4.5. expenditure  tax  concept  to  housing  is  such  described  in  intervention.  in which housing  The significance of the section  4.6,  while  tax  expenditures and housing finance are discussed in section 4.7. Ways to curtail tax efficient housing investment are mentioned in section 4.8. intervention are listed in section 4.9.  government  Other forms of  The last section,  section  4.10 compares tax expenditures with direct subsidies. 4.1 Introduction The relation between taxation and economic growth has long been a matter of  concern  to policy makers  and  students  of public policy . 54  The  classical  economist analyzed the effects of taxation on growth and the related question of  distribution  of  incomes,  stability  taxation  on  analysis.  Subsequently,  rate  of  the  growth  objectives,  of  while of  became  the effects of taxation,  national  income,  Quoted in Bird and Oldman,  on  1990.  46  an  the  important  effects  of  subject  of  on the distribution and the  employment  Gillis et a1 , 55  (19O) p 1.  economics,  Keynesian  economics  were also studied.  Bird and Oldman, 54  in  and  on  other  policy  list the objectives of fiscal  policy  the  as  disparities  promotion  between  of  economic  households  and  stability and economic efficiency, endowments.  resource  development,  such  as  role.  dimensional  In  a  mixed  India,  growth,  regions,  the the  reduction promotion  of  income  of  economic  and the increasing of returns from natural economy  fiscal  that  policy  is  pursuing  plays  a  To quote the Seventh Five Year Plan  planned  central (1985-90)  economic  and  multi  document of  India,  “Through it (fiscal policy) the government creates and sustains the public economy consisting of the provision of public services and public investment; at the same time it is an instrument for reallocation of resources according to national priorities, redistribution, promotion of private savings and investments, and the maintenance of stability 5  The principal way in which fiscal policy influences growth is the  efficacy,  policy  also  allocation,  or  otherwise  affects both  of  growth  within  the  mobilizing by  resources  influencing  public  the and  economy  for  through  development.  efficiency  without.  In  Fiscal  resource  of India,  fiscal  57 policy has been used extensively for giving special inducements for savings The current phase of economic development in India has  led to a large  increase in its urban population; and consequently a huge housing shortage. To provide affordable and adequate shelter for all, finance and an efficient delivery system is finance raise  system based on  the  bulk  of  its  the principle resource  of  the availability of adequate  essential.  n efficient housing  competitiveness  requirements  by  should be  mobilization  savings in competition with other participants in the market.  Acharya, 56  (1988) p.  Acharya, 87  (1988) p 290.  287.  47  of  able  to  household  It is difficult  for the housing sector, the  at its present stage of development to rely solely on  determined  market  system  where  resources  sectors that offer the highest return.  Thus,  are  likely  to  be  driven  to  there is need for the government  to intervene to ensure that adequate resources are mobilized to meet housing needs.  Taxation  policies  are  one  form  of  such  interventions  through which  government attempts to attract resources to the housing sector. Taxation The  country.  instruments  policies term  “fiscal  influence  to  . 58 economic welfare such  as  growth,  reduction and  form  an  important  policy” the  applies  working  of  Fiscal policy makers of  the  rate  redistribution of  of  part  the  to  fiscal use  economic  the  policies  of  public  system  to  of  a  finance maximize  concentrate on specific objectives,  inflation,  income.  of  The  acceleration  instruments  of  of  the  fiscal  rate  of  policy are  both revenue and expenditure. Among the revenue instruments the most important role is played by taxes; however governments also rely on fees, of public utilities and on sales of assets.  on the prices  In addition to providing revenue,  each tax can also be used to achieve particular goals. In many incentives for  a  countries  there  appears  to  be  a  propensity  to  in response to almost any new or promising investment  backward  region,  stimulus  to  a  new/existing  industry,  desired services like housing for the poor and not-so-poor;  tax  introduce idea.  Help  provision  of  all of these have  been and are the objectives of investment tax incentives in many countries . 59 4.2 Reasons for Government Intervention in Housing  While there is a divergence of opinion as to whether housing should be  Taflzj 58  (1990)  Boskin and Mcclure 59  (1988)  48  treated as a free market or as a social need,  it is  widely accepted that even  though the market can be used to allocate much of the housing stock,  there are  particular problems that require public intervention for the reasons ° listed 6 below:  -  Housing  1)  policies  favouring  the  poor  can  be  used  as  a  means  of  redistribution of income towards the poor, who would otherwise suffer from bad housing condition as a consequence of poverty. “merit  whose  good”  consumption  is  Housing is considered to be a  politically  acceptable  to  promote.  Poor  housing exacerbates other personal problems and can yield to growth of social evils. 2)  Governments  income;  and  to  intervene to attain vertical equity through redistribution of attain  horizontal  equity,  by  tax benefits  that  aim  towards  tenure neutrality. 3)  Government interventions ensure that the true effect of externalities,  and  spillover effects of improving one’s house on the neighbourhood are accounted for. 4)  High cost and long life of housing means  against  uncertain  encourage  future  investments  in  income. housing  By public in  it  requires  intervention,  keeping  with  long term finance, it true  its  is  possible  value  to  to the  society. 5)  Intervention  may  be  done  to  promote  interests  of  a  particular  group.  Mobility of labour can be promoted by giving access to subsidized housing to job movers. Rent control,  subsidy policy,  and policies to provide stability to  mortgage interest rates; can be and have been used to counter inflation.  60  Hills,  (1991)  49  6)  Intervention for wider political or social aims may be resorted to.  may be  to promote  a  formation of ghettos. concessions  to  social  mix of  people  in neighbourhoods  and  This  to prevent  This can be in the form of provision of subsidy or tax  certain groups  Interventionary policies  who  that  are  to be moved  encourage  to  a particular region.  owner-occupiers  may  be  used  in  an  effort to create a “property-owning democracy” , based on the assumption that 61 property owners are more conservative and less inclined towards revolution. 7)  The  market  allocation  of  mechanism  is  property.  unlikely,  As  the  generally unevenly distributed,  on  its  own,  to  of  land  and  ownership  so the market  is not  produce  an  housing  efficient  property  is  likely to allocate the  income from these in the way the community would wish. For these reasons markets,  all governments  intervene  although to widely differing degrees. regulatory  framework,  in urban land and housing  Intervention takes many forms,  including  a  activities,  and direct ownership and participation in urban investment and the  taxation,  subsidies  to  particular  provision of services. 4.3 Problems Associated with Public Intervention Several practical issues have proved problematic when designing suitable means  of  intervention.  These  affect  the  choice  of  techniques  and  the  distributional consequences of such intervention. 1.  Multiple objectives:  the hope  of  meeting often  any tax should not modify allocation  Hills 61  Many  (1991)  distort in  interventionary techniques  incompatible,  multiple  the working of  objectives.  the market,  line with defined objectives;  p 21.  50  are  it  introduced with Theoretically,  except positively to should be  equitable,  treating those in similar circumstances similarly, to redistribute  from rich to poor;  and it  easy to collect and difficult to evade. these  meets  requirements  in  principle  but capable of being used  should be a good revenue  source,  The problems of devising a tax that alone  are  very  great;  even  without  considering the practical difficulties of implementation . 62 2. Undesirable side effects: Many policies operate in unpredictable ways. Even if  the  government  consistent  with  has  been  their  able  to  achievement,  specify  objectives  unwanted  side  and  effects  design policies  may  significantly  reduce their value. 3.  Technical problems of definition and operation:  extremely  difficult  to  turn  theoretically  These arise because it is  straightforward  interventionary  approaches into operational policy instruments. 4.  Perversion of instruments to meet other ends: A tax incentive may be used  by interest groups to promote a particular activity, useful  in  powerful,  the  government’s  then  it  would  be  perspective. politically  If  the  difficult  which may no longer be interest  group  to  the  alter  is  very  provision.  Advantage may also be taken of the intervention to create tax shelters;  and  thus evade taxes. 5.  Legal  and  intervention,  administrative the  legal  problems:  provisions  are  In  an  generally  attempt made  to  fine-tune  complex.  It  may  administratively difficult to determine the eligibility for concessions. each  intervention  is  discriminatory  against  they may challenge the policy legally.  (1991)  51  some  people  not  the be  Also  benefitted and  4.4 Definition of Tax Expenditures A tax expenditure is usually defined as a departure from the generally accepted  structure  tax  that  produces  a  favourable  treatment  of  particular  types of activities or groups of taxpayers. Tax expenditures can take the form of:  1)  the  tax  tax exemptions, base;  where income from particular sources  tax  2)  allowances,  where  sums  are  income in order to arrive at the taxable income; deducted exceed  from  directly  liabilities;  tax  taxpayers  are  liabilities,  tax  subject  and  rate  reduced  to  emphasizes  the  proposition  structured  as  a  direct  4)  that,  and  reliefs,  rates  of  program  may not  or  tax.  all  be  specific  The  and  from  tax credits,  where  in principle,  expenditure  deducted  3)  may  is excluded from  term  assessable amounts are allowed  to  activities  or  tax  expenditure  tax expenditures  thus  evaluated  can be  in  direct  expenditure terms. Though the notion of tax expenditure appears to be an oxymoron, a  basic  logic  to  the  . 63 concept  The  way  in which people  there is  and business  are  treated for tax purposes gives the government enormous power over the amount of money income that people finally get and keep. on the fact that the tax system is not neutral,  people in like circumstances  are not treated equally in the way they are taxed. which  the  system  tax  is  used  as  a  Tax expenditures are based  They concern the extent to  deliberate  distribution of money income that would prevail  instrument  to  change  the  if taxes were truly neutral.  Tax expenditures are more subtle and far-reaching than transfer spending. 4.5 How Housing Enters the Tax System Taxes  can  Peterson,  be  (1991>  divided  into  those  p 57.  52  on  income,  consumption,  wealth  and  transactions. Housing could enter each of these tax bases. A landlord’s income from rent,  owner occupier’s  income  from sale of housing property) of  housing  services  received in kind,  by  all  (the imputed rent),  capital gains  (income  can all be subject to taxation. The consumption households,  can be taxed.  whether  paid  for  through  Residential buildings are one of  rent  or  the single  largest component of net personal wealth and their property value is subject to wealth tax.  Transactions  involving transfer of property are registered on  payment of stamp duty. Taxation  of  housing  is  difficult  poorly measured by cash flow payments.  because  its  true  economic  costs  Cash flow costs of housing may combine  the purchase of both current consumption and of an investment asset. costs may also be hidden, stake  in  a  house,  period of time.  or  The  effects  prices,  that  only  becomes  Returns from housing often come in kind  of  tax  meaning that  Housing  in the form of opportunity cost of an owners’ equity  depreciation  accrue over long periods  are  apparent  over  a  long  (as imputed rents)  or  (as capital gains) with only infrequent transactions.  concessions current  or  subsidies  recipients  may  are not  the  be  capitalized  in  house  true beneficiaries  from  them. Housing subsidies.  tax  expenditures  (HTE5)  are  an  important  They have frequently evolved along with  source  of  taxation systems,  housing rather  than being specifically designed to aid housing consumption or production. The increasing severity of constraints on government budget deficits has elevated the  issue  of  HTE5  beyond that  of mere  academic  curiosity.  Some  governments  have sought to curb their growth by reforming the tax treatment of housing. 64  Hi11s,  (1991)  53  In  case  the  of  owner-occupied  housing,  the  definition  of  a  tax  expenditure requires the identification of the normal tax treatment accorded comparable  to  assets  or  goods.  Housing  could  be  considered  an investment asset or a financial asset.  consumption good,  either  a  The way in which  housing is given favourable tax treatment depends upon the category in which housing is placed. In analyzing housing tax expenditures, housing as an investment asset,  economists have tended to treat  in recognition of the fact that the taxable  capacity of the owner-occupier is greater than that of the individual with the same  income,  money  This  income.  if  could,  is  who  is  because  let,  generate  not  the a  a  house  money  would be on par with the tenant, but with greater money income, systems  will  distort  the  home-owner, of  the  income.  allocative  sector,  and  distortions the  ability  owner In  rent  occupier  that  event,  out  is  between the  of  an  the  and liability to pay more tax.  allocation  of  pays  taxable  asset  that  owner-occupier  in having to pay for rental accommodation,  of  between different types of expenditure. to  but  resources  if  they  Also,  are  taxation  not  neutral  Increasing attention has been devoted  owner-occupation housing  sector  and  to  the  private  appropriate  rented  funds  and  resources that would otherwise have been channelled into capital investment in the  industrial  sector.  This  suggests  that  owner  occupied housing  and other  investment expenditures are sensitive to relative rates of return,  and a tax  system seeking to minimize distortions should,  therefore,  accord housing the  same tax treatment as other investment goods. In  traditional  neo-classical  economic  models,  perfect  mobility  of  capital and labour is assumed. Capital flows into the tax subsidized sector in response to higher post-tax rates of return, 54  and output increases until post  tax rates of return across the economy are equalized by price adjustments.  If  there is no balanced reduction in government expenditure to offset reduced tax revenues,  and if productivity levels  than the rest of the economy,  in the tax subsidized sector are lower  there may be a detrimental effect on the long-  run growth of national output. However, about the  “crowding out”  unwarranted,  Wood  (1990)  states that such concerns  of industrial investment by the housing sector,  unless productivity levels  are  in the housing sector are relatively  Econometric estimates using annual data from Australia from 1956-1985 do  low.  not indicate any “crowding out” of industrial capital,  thereby not suggesting  lower productivity levels in the housing sector . 65 There is a potentially significant influence of HTE5 on the governments’ balanced rates  budget.  and  on  tend  incomes  real  information  They  the  cost  and of  to  grow  automatically  thereby HTEs  to  erode  tax  governments  with  revenues. in  billion in fiscal year 1988 as  There  terms  Available evidence suggests that in USA the cost of HTE5 has grown rapidly during the 1980s.  inflation,  of is  interest little  is  revenue  loss.  significant and  In US the budgetary cost of HTE was  compared to direct budgetary outlays  $49  for low  income rental households of $11 billion  They  HTE5  erode the  also  affect  returns  on  allocative  housing  households and firms.  wood, 65  tax base and thus  assets  efficiency, and  by  influencing  consequently  Equity is affected,  (1990)  (1990)  affect governments’  p 55.  55  changing  budget deficits. relative  the  rates  behaviour  of of  because they alter the relative tax  burden among individual taxpayers, and between occupiers and tenants . 67 are  There expenditures. misleading,  conceptual  If  they  are  replacement  but  problems  in  estimating  ignored  direct  of  expenditures  tax  public  the  cost  expenditure  by  direct  of  totals  tax are  expenditure  is  difficult if they are not recognized as subsidies. HTEs are generally applied in the private housing sector,  and are directed at consumption and provision  of owner occupied and private rental housing. three levels in the economy: of  housing,  return on  they  a)  They have potential effects at  in the national economy- by raising the rate  can  reduce  investment  business and thus negatively affecting employment;  in  other  b)  in the housing sector,  by encouraging tenure shifts towards owner-occupation, consumption  and  production;  and  in  c)  the  urban  assets,  such as  and increased housing  housing  market  through  unintentional but explicit impacts such as urban sprawl,  income segregation in  residential  areas  areas,  population  loss  in  HTE5  tends  central  city  municipal  and  government fiscal problems . 68 The  formal  incidence  of  to  be  , 69 regressive  with  as  a  progressive tax rate structure, any given tax exemption or allowance generates a larger absolute reduction in the tax burden with rises the  choice  of  owner-occupation  has  a  positive  income  in income.  elasticity,  proportion of owner-occupiers fall in the upper income groups.  Wood, 67  (1986)  Boleat, 68 Wood, 69  p 9.  (1986)  (1986)  56  a  larger  The size of a  tax exemption or allowance tends to be directly proportionate to of the household.  Also as  the income  As for the effective incidence of HTEs; the beneficiaries are purchasers as they are partly capitalized into house prices. This increases their cost to governments,  because higher house prices  increase  the  size of  those housing  costs and sources of housing income that are accorded tax allowance and tax exemption status. Higher house prices also lead to the requirement of a larger amount of subsidy needed to be given to lower income groups for housing. Generally all types of housing tenure are subsidized through HTEs,  and  therefore households have an incentive to switch from non-housing expenditures to  housing  expenditures.  The  regressive  nature  of  owner-occupied  HTEs  encourages higher income households to demand more housing, while preferential tax  treatment  expense  of  of  this  rental  tenure  tenures.  encourages  growth  There may also  be  in  occupation  differential  Since the demand for the quality and environmental income elastic,  owner  spatial  at  the  effects.  attributes of housing is  demand may be greater in lower density areas such as suburbs,  thereby encouraging urban sprawl. Housing  is  a  significant  capital markets HTE5  component  can be the source of  of  the  macro-economy.  In national  crowding-out pressures by raising  the rate of return on housing assets. Housing would then be attracting finance that would otherwise have funded private sector investment. HTE5 may have a detrimental  impact  on labour supply,  if  In labour markets, erosion of  the  tax  base requires increases in marginal tax rates to maintain revenues. Tax expenditures cause the demand for housing and house prices to rise in  the  short  expansion  wood, 70  in  . 70 term supply.  In  the  long  Tax provisions  term,  house  favouring  (1986) p 21-22.  57  prices owner  are  moderated  occupiers  by  increase  an the  of  proportion  owner-occupied  housing  in  the  housing  stock,  and  expand  the  housing stock in the long term. House prices and production are increased more at  the upper end of  the market,  and upper  income households  will  exhibit  a  greater propensity to become owner occupiers. HTE5 may ultimately subsidize general if households  repeatedly realize their equity holdings  consumption expenditures. capitalization) participants,  consumption rather than housing,  The secondary impacts  in order to  (particularly,  the degree of  of HTEs that arise as a result of behavioral changes by market  are  of  critical  significance  to  a precise  measurement  effective incidence of tax benefits at different income levels. process  has  opportunities this  been of  used low  to  justify  income  groups;  the  use  but  of  there  HTEs is  no  to  of  the  The filtering  improve  evidence  to  housing support  71 In principle HTEs  can have  the same macro-economic  equivalent direct subsidy program.  can be  considered more  consequences as  They can encourage urban sprawl,  factors such as improvements in transportation technology, etc.  increase  significant  in this  respect.  an  but other  real income growth Income  segregation  and polarization in urban housing markets are frequently cited as a product of the unfettered operation of market may  lead  tenure tenures  to  polarization  choice preclude  and  forces.  income  However,  segregation,  entry by moderate  government if  other  impediments  to high income groups  72  4.6 Significance of The Tax Expenditure Concept to Housing Policy  Wood, 71  (1986)  p 24.  (1986)  p 25.  58  interventions  into  to  rental  The conceptual and measurement problems associated with tax expenditures have tended to preclude their close scrutiny. This is particularly true in the case of HTEs,  as the consideration of taxation policy is examined separately  from the administration of government housing programs. emerged  as  housing  policy  the  tax  system has  goals.  Thus,  evolved, HTEs  are  rather  Often the HTEs  than being  73 considered  to  designed  be  the  have  to meet  source  of  unintended  impacts.  discussion,  as it reflects a conflict between the principles and practice of  taxation,  This  perception  raises  important  issues  for  policy  the goals of housing policy and macroeconomic performance.  Tax allowances can be invoked in respect of either acquisition costs or occupancy costs. Acquisition costs are those that the purchaser must incur in securing  housing  payments,  stock  mortgage  by  purchase,  interest  and  and  principal  include  transaction  repayments.  costs,  Occupancy  downare  costs  incurred in the process of consuming housing services yielded by the housing stock purchased and,  include  rates  payments,  depreciation,  utility charges,  maintenance and repair expenditures. Some  countries,  such  as  UK,  exclusively on acquisition costs. and  improvement  allowances  of  the  encourages  low occupancy costs.  housing  to  stock,  prompted  wood, 73  OECD  almost  as  the  pattern  of  tax with  Correcting this imbalance may encourage demand for older  maintenance some  allowances  choose newly constructed dwellings  housing and stimulate maintenance and improvement. furthering  tax  This may be detrimental to the maintenance  existing  households  concentrate  and  improvement  of  such  as  governments,  (1990)  59  the  The importance attached to  existing  France,  housing  Ireland  and  stock, Sweden  has to  introduce new tax allowances designed to promote these objectives . 74 4.7 Tax Expenditures and Housing Finance Markets Many governments have introduced favourable tax provisions designed to promote  the households’  ability to make down payments  for house purchase . 75  These provisions operate in combination with special savings schemes operated by HFIs.  Preferential tax treatment of savings schemes commonly takes the form  of tax exemptions accorded to the interest return and bonuses received by the savers. HFIs  Though regressive in their formal incidence,  to attract  funds at a lower cost.  This benefit can be passed onto the  home-owner in the form of low interest mortgages. Austria and France, attract  In some countries,  such as  the bonus and HTEs are critical to the system’s ability to  entrants,  new  these provisions enable  which  is  necessary  to  meet  outstanding  loan  . 76 commitments Non-contractual savings schemes,  such as those operated in Canada, carry  no loan entitlement. They represent an attractive method of tax-free saving to meet down payment requirements. By limiting the access to tax-favoured schemes to prospective home purchasers  (perhaps first-time),  tax shelter possibilities  are restricted. There are potentially important finance market . 77  repercussions  (1990)  Boleat, 75 76  (1986)  Boleat,  (1986)  Boleat,  (1986)  for  the housing  These arise because a HTE will increase demand for housing  and this in turn will raise the demand for mortgages.  Wood,  of HTE5  60  In general, HTEs will be  partly  capitalized  liabilities  of  into  HFI5.  the  The  interest  extent  rates  of  prevailing  capitalization  on  will  the  assets  and  upon  the  depend  competitiveness of the housing finance market. 4.8 curtailing Tax Efficient Housing Investment  Private  rental  housing  in  such favourable tax provisions,  some  countries,  such  revenue  and  forgone,  efficiency losses.  is  USA,  has  attracted  that housing assets are being used as a means  of sheltering other sources of income from taxation. of  as  also  a  source  of  This is costly in terms  allocative  distortions  and  These circumstances are particularly evident in countries  that use HTE5 to encourage private landlords’  acquiescence to rent controls.  This is done by allowing deduction of operating costs from taxable income and exempting controls, to  capital  gains  from  taxation.  With  stringent  application  of  rent  it is common for private landlords to incur losses that can be used  shelter  other  sources  eventually eliminated,  of  income.  tax burdens  If  rents  rise  so  can be minimized by  that  taking  losses  are  advantage  of  favourable capital gains provisions, and selling to owner-occupiers. 4 .9 Other Forms of Government Intervention  Subsidies  in  the  form  of  low  interest  loans  may  lead  rents  to  fall  eventually as more new building occurs; but eventually house prices will rise. Program funding is generally insufficient to provide subsidized dwellings for all eligible households, subsidized housing. rents  by  non-profit  An increase housing  rents in the short run, other  housing.  considerable  If  and therefore can lead to inefficient allocation of  agencies  can  result  in  lower  house  and  prices  resulting in the eventual decline of the provision of  rents  variation  in the provision of housing at below market  are in  set  the  at  rent 61  historic paid  for  cost  levels,  equivalent  there  may  housing.  be  Such  rents  administered  provide  no  incentive  to  utilize  the  housing  stock  efficiently. Application of rent controls also results in administered rents and if applied  consistently  across  the  rental  housing will deteriorate and decline.  tenure  the  sector,  stock  of  rental  This will be accompanied by a rise in  house prices and an expansion of owner-occupied housing,  resulting in higher  land prices leading to the realization of holding gains by the owners of land upon which new housing is built . 78 improvement  Home stock  of  housing.  If  subsidies the  reduce  price  the  cost  elasticity of  of augmenting  improvement  there will be little net addition to the housing stock. prices  properties  of  composition  of  net  eligible  additions  improvement  for  to  the  housing  activity  is  is  low,  The demand for,  subsidies  stock  the existing  may  likely  rise.  to  change  and The in  favour of conversion and renovation to the existing housing stock. 4.10 Comparison between Tax Expenditures and Direct Subsidies Under  strict  assumptions,  equally efficient . 79  If  the  reflects  subsidies  the production of  firms and households nearby, that  taxation,  social  and direct  a good results  in  controls  costs  are  to other  the government may impose a tax on the producer costs  each  at  level  of  output.  In  this  way  externalities are internalized and the decision makers will modify production in line with the true marginal social cost. Output will be reduced because the externality  is  taken  into  and  account  This form of intervention is regressive, 78 owners,  who  are  already better  of f;  at  the  weighed  against  the  benefits  as it puts more income in the hands of property  expense  of lower income tenants, who due to contraction in the supply of rental stock, pay higher rents and/or make do with less housing. witehead, 79  of  (1983)  62  the  Equivalently,  production.  a subsidy can be given as  an incentive to curtail  production in cases where social costs offset private benefits. the  difference  only  producer of  community  distributional  costs  rewards  suffers him  equitable  approach,  redistribution  or  the  useful  of  income,  source  allocation.  efficient  financing  require  although  Subsidies  from  not  in in  causing  the  the  while  in the  additional  costs  to  are  additional  merit  goods.  Taxation  use  may  cause  similar  This  developing  case  income,  there  its  first  the  taxation is usually regarded as a  present  somewhere.  particularly in  governments,  of  effects,  reduction  costly,  unless  provision  a  for  Where the externality is  society. more  in  external  the  the  second,  lies  In principle,  presents  objectives also  further  allocation a  countries.  major  provides problems  problems  problem  Housing  tax  of  for  a of  and all  expenditures  encourage private sector participation rather than government-centred decision making.  By offering financial incentives on a voluntary basis,  use of coercive instruments of government and  direct  subsidy programs  are  more  intervention.  likely to  Alternative  indirect  involve government  controls  over the provision/production of goods and services; replacing  market  participation, The  forces  as  implementation. and scrutiny,  inducing  and so run the risk of  withdrawal  the  of  private  sector  as compared to the cooperation encouraged by HTEs.  provisions  administer,  and  they avoid the  no  of new  Further,  tax expenditure programs bureaucracy  is  are  required  simpler for  the  and  easier  purposes  to of  as these programs are not subject to regular review  they are not changed frequently.  63  They may be viewed as helping  to preserve the stability of a subsidy 80 respond  Households  more  favourably  to  tax  subsidies  than  to  direct  subsidies. An advantage of benefits paid to households through the tax system is  that  they are  subsidy  programs  application This  less  likely to be made automatically.  tend  process,  to  require  which  the  claimants  time  consuming  individual’s  receipt  “visible”  of  subsidy.  and induce a reluctance to  initiate  in principle, assist the private rental and owner-  occupier tenures equally . 81 forms  indirect  Tax expenditures favouring the rental sector are  of  assistance  provided  in  encouraging the construction of new rental housing. opportunity  and  direct  thereby lowering take-up.  Tax expenditures can,  normally  more  highlights  can stigmatize potential  valid claims,  a  In contrast,  designing  of  equity is to be preserved,  more  horizontally  form  the  of  incentives  Such measures offer the HTEs.  equitable  If  horizontal  the housing allowance programs should be based on a  consistent measure of housing costs across tenures. Tax expenditures are seen as a form of government spending available to meet objectives that the government considers to require financial assistance.  Any  financial  expenditure  aid  or  as  or a  incentive  direct  program  program,  or  may a  be  written  combination  either  of  both.  as The  a  tax  choice  between tax expenditures and direct programs is not an easy one.  Very little  is  or  whether  as tax laws,  especially  known  about  Wood, those  that  just  (1986)  confer  what  However,  tax  factors  influence  this is not true in the  expenditures  are  changed  examination. Smith, 81  (1981) p 456.  64  such  a  Indian context,  frequently,  choice  presumably  after  review  and  re  governments recognize that a choice is possible . 82 Several negative characteristics are attributed to tax expenditures that are equally applicable to direct spending programs also: 1.  They pay recipients to engage in activities that they would engage in any  way, 2.  that is,  they have a windfall effect.  They distort the choices of marketplace and the allocation of  But,  if it was not so,  they would have only a windfall  resources.  effect. The government  assistance provided is the lever to bring about desired change. 3. They keep tax rates high. 4.  They are open-ended,  that is,  they are available to any eligible taxpayer,  who meets the eligibility requirement,  and so their costs cannot be forecast  accurately. 5.  They  allow  determination  taxpayers of  to  eligibility,  decide is  on  their  present  in  own  eligibility.  direct  spending  This  self-  programs  also,  where the beneficiary must apply for assistance. Some  other  of  aspects  tax  expenditures  insignificant in direct spending programs. “Upside  down  . 83 effect”  Tax  expenditures  people with the highest marginal tax rates. tax program would be so structured.  are  either  absent  or  are  The prime example of these is the work  to  the  greatest  benefit  of  It is very unlikely that a direct  The upside down effect may be eliminated  or mitigated in many ways; by using a method such as a taxable credit against tax; or by using a tax expenditure that vanishes at a certain income level and so benefits only people below that income. A refundable tax credit may counter  surrey and McDaniel, 82  (1985)  surrey and McDaniel, 83  (1985).  65  the  effect  expenditures rates  are  of  exclusion  are  dependent  reduced,  they  into  tax  the  their presence,  on  also  . 84 become more expensive woven  of  non-taxpayers. the go  regular down;  Almost  tax rate  when  tax  by  definition,  structure,  rates  are  so,  provisions.  Tax  expenditure  are not widely circulated.  budgets,  when tax  increased,  Tax expenditures enjoy lower visibility, which  tax  they  as they are acknowledge  Focusing on the tax aspect of the  tax expenditure permits debate to shift away from the real issues. It is difficult to predict the use of tax expenditures. They can be used to  provide  tax  narrow focus, This  results  middlemen-  shelters.  Most  tax  expenditure  provisions  initially  but tax professionals soon learn to use them as in non-productive  investors,  brokers,  (for  the  lawyers,  encouraging rent-seeking activity.  economy as accountants  Tax planning,  a whole) and  have  tax shelters. expenditure  tax  a  planners,  on  thus  resulting in tax avoidance,  somehow does not encounter similar societal censure as welfare fraud (which is misuse of direct subsidy);  and thus goes largely unchecked.  Tax expenditures  are often viewed as escape routes for favoured individuals and corporations. Tax expenditures are largely responsible for the complexity of tax laws and tax administration. programs. would  be  They also lead to confusion over responsibility for  If a tax expenditure was rewritten as a direct spending program, in  the  operative  jurisdiction  of  the  appropriate  agency  in  it the  executive branch- without involving the treasury. But as tax expenditures they are administered by the treasury required expertise, This results in,  (or the finance ministry)  which may lack the  and to obtain this expertise has to divert its resources.  say,  a housing tax expenditure being evaluated not by housing  This again emphasises their regressive nature. 84  66  experts, or for its value in providing housing, but from the perspective of a tax  administrator.  Better  co-ordination  between  the  treasury  and  the  appropriate agency, at least at the time of formulating and evaluating the tax expenditure, can ameliorate this situation. Tax  expenditures whereas  economy,  direct  enjoy  acceptability  subsidies  from  the  as  subsidies  government  are  in  a  viewed  capitalist as  being  socialist in nature. They are more securely embedded than direct programs and are  thus  easier  by  expected to remain in effect the  fact  that  they  utilize  administration.  67  longer. an  Their  implementation is made  established  framework  of  (tax)  CHAPTER FIVE  HOUSING TAX EXPENDITURES IN INDIA This chapter discusses the housing tax expenditures used in India. first section,  5.1,  discusses the nature of India’s fiscal policy.  The  Section 5.2  describes the various tax policies relating to housing in India. 5.1 Introduction India’s for  resources  fiscal  policy  economic  is  motivated primarily by  development.  maintenance of economic stability,  It  also  with the first Five-Year plan (1951-56)  fiscal policy has countries, saving,  perhaps  influence private  public investment,  it  is  social  equity,  This policy framework originated  complex and pervasive.  because  on  and developed in new directions as the  longer reach and a  a  focuses  to mobilize  and allocation of resources according to a  predetermined scheme of economic priorities.  planning process became  the need  a  Under  Indian conditions,  different connotation than  principal  instrument  saving both in magnitude  to  in other  augment  and disposition,  the  public finance  and determine the pattern of income distribution . 85  The Indian investor is fiscally oriented and a very large proportion of savings  accessed  schemes. extent  by  the  government  The availability of  the  resource  result  the  concessions  of  determines  fiscally to a  flow to a particular sector or activity.  variety of tax incentives, of disposable  fiscal  are  oriented  significant  By offering a  Indian fiscal policy has influenced the allocation  income of the household sector,  non-incorporated enterprises.  It  has  been used  the corporate sector, to  induce  the  and the  household  and  other parts of the private sector to hold their savings in desired investment  Khatkhate, 85  (1991) P 254.  68  . 86 instruments  Some investments enjoy tax preferences to such an extent that  the resulting return to the investor is extremely high. 5.2 Taxation Policies Affecting Housing in India Ph1  ————  ‘  1  .  —.—.  Trn -------  ri  —--  Tnd —--  t,f  Investment  h,-iiqinrt  nrl  rd-hr  Interest payments  Return  Capital gains  Imputed rent is taxed  Taxed  Rents taxed  Taxed  after Taxedallowing depreciation No Tax  Taxed  on  amounts  Owneroccupiers  20s allowed as tax credit*  Private Landlords  20 allowed as tax credit*  Other business investment Other consumption Other savingssuch as bank deposits, approved savings Shares  Exemption specified sectors No relief  for  No relief  Exemption specified sectors  for  borrowed investment Tax-relief upto 10,000 annum Tax-relief upto 10,000 annum Interest fully deductible No relief  for  Rs. per  Rs. per is  No Tax  Fully Deductible  Tax relief upto Rs. 7,000 per annum  Not applicable  Fully deductible  Dividends relief taxedallowed for new approved companies  Real gains taxable  Source: Constructed with information from the Indian Income Tax Act, 1992, and subsequent amendments. ** The total investment eligible for tax credit is limited to Rs. 10,000 per year. Table India.  Such  5.1  highlights  policies  the  influence  features the  of  housing  taxation  relating  situation  for  to housing  taxpayers  in  only.  Considering that less than one per cent of the total population pays income 86  by allowing interest paid on them; and sometimes the amount invested also; to be deducted  from the taxable income.  69  tax  (only 8 million out of a population of 900 million are income tax payers  in 199487),  tax policies that give a fillip to direct  investment in housing  can only have limited impact. Increased housing activity has a large employment and skills multiplier effect  in addition to backward and forward linkages with related industries, construction materials,  such as,  furnishings, paints,  accessories and consumer  durables. As most housing construction in India is done manually by unskilled or semi-skilled labour who come from the lowest income group,  fiscal policies  to boost housing activity are sure to have a positive effect on the income of the poorest sections. To  encourage  generally not who invest  investment  in  income tax payers,  housing  for  low-income  groups,  who  are  weighted concessions are given to employers  in housing for their employees.  This policy has  improved housing  conditions of factory and plantation workers. However these workers and their families are assured of housing only as long as one of their family members is employed  in that concern.  residing  in  them,  there  Also, is  as  very  is  such housing little  not  contribution  owned by the people by  the  residents  in  improvement and maintenance of the housing stock. To ameliorate the housing situation of the urban poor, government has to either  itself,  or  by  provision  of  finance  building of housing on a massive scale. financial  resources  institutions  set  up  that  can  be  specifically  For this,  raised  for  the  to  by  private  sector,  ensure  the main requirement is of  channelling  financing housing.  If  the  savings  their  income  in is  taxed at concessional rates then these institutions can provide housing loans  T1-ie Economic Times 87  (10th February 1994)  70  at  lower  through  interest  tax  rates.  rebates  and  Deposits these  to  deposits  such  institutions  can be  used  to  can  be  finance  attracted or  building  purchase of houses. Ph  5.2: Home  r,,11r-  T.,,  lm  in  Amount of loan Loan as a multiple accumulated savings 4 times 3 times 2 times 1.5 times Source: Rao,  Upto 50,000 50,001-100,000 100,001-200,000 above 200,000  Rate (%)  of  10.5 12.0 13.5 14.5  (1991) p 74.  Home  The  Annual 88 interest  (Rs.)  of  Loan  Account  (HLA)  Scheme  a  is  loan-linked  saving  scheme  introduced by the NHB, which was set up in July 1988 to fill the lacuna in the Indian housing finance system that has been a major inhibitor  in the growth  and development of the housing sector. The HLA scheme was introduced from July 1,  It  1989.  is  basically a  deposit  positive real rate of return of 10% savings and an assured loan  linked  anywhere  in projects  in  India  that  offers  users  open  a  HLA  with  a  tax concessions on  (with tax concession on installment repayment)  financed by NHB).  can  scheme  (compounded annually),  house building after a period of 5 years house/flat  loan  for  (3 years in the case of purchase of a  Any individual, any  branch  of  not owning a house designated  banks. The account holder has to save regularly for a period of 5  scheduled  (or 3) years  after which a multiple of accumulated savings can be availed of as a loan. As Table  5.2.  eligible  The 88 bankers  shows,  the scheme  for getting a  annual  interest  is  favourable  larger multiple  rate  charged  by  banks  of  in  to  lower  their  India  income groups,  savings  was  18  in  as  loan,  1991.  The  who are and  at  a  indigeneous  and informal credit sources give mainly short term loans on which they charge monthly  interest at rates upto 5 The annual compounded rate of interest on such loans may be as high as 75.  71  lower rate of interest. savings  The  under  the HLA scheme  qualify  percent of the payment of principal of the loan is  to  eligible  qualify  for  Interest on the loan is  a  tax  credit  under  tax concessions.  (up to Rs. section  accumulated savings under the HLA Scheme,  IT act.  of  the  IT  act.  income  Similarly the amount of  together with the interest is exempt  The housing situation in India for the middle far from satisfactory.  10,000 per annum)  88  subject to the overall ceiling of Rs.  (WT),  Twenty  eligible for deduction in the computation of  from house property under section 24 of the  from Wealth Tax  for  500,000.  income groups 89  Making interest on mortgages tax-deductible,  is also fully as  in the USA,  or upto a certain limit as in UK.;  activities.  This will directly increase investment in housing for the middle  income  and will  groups  whereby  total  the  benefit  the poor  supply  housing  will give a boost to housing  through the process  increases  and  of  vacated  “filtering” income  middle  accommodation becomes available to the poor. Rationalization of stamp duties and registration fees ° on residential 9 property transactions the  influence  of  would encourage  parallel  economy on  their this  registration and perhaps sector.  The  parallel  sizable and is disproportionately present in the housing sector.  89 year. year  The middle  income groups  (from fiscal year 1994-95)  payers,  .  another  7-8%  of  12,000-50,000 per 35,000 per  (primary source of income for about 70% of the population)  population.  So  out  of  employed in the informal sector are also excluded, about 10%. So,  is  Residential  which is levied above the threshold income of Rs.  Also income of tribals residing in tribal areas is exempt.  the  economy  (The main reason for only 1% of the total population being tax  is that agricultural income  exempt from IT and WI. for  in urban areas have income ranging from Rs.  They usually pay income tax,  reduce  the  remaining  22-23%,  1%  pays  is  This accounts IT.  then the population that is taxable,  If  people  works to  it can be said that 10% of the taxable population pays income tax.)  mese are charged on the market value of property. However, 90 heavily understated.  72  property values are generally  land are among the main assets  property and marketeers policy,  their undeclared profits.  invest  in which speculators A fiscal  and black  and municipal  taxation  including a levy of tax on vacant urban land and residential property  in order to curb speculative activities,  will  result  in increased supply of  land and buildings and will lower their prices. there is a shortage of supply of building materials,  In India,  cement and steel. The prices and supply of these items are government.  There  is  need  for  rationalization  of  such as  controlled by the the  structure  of  manufacturing duties levied on these items to ensure increased production and supply. steel,  As  the  bricks  vagaries of  supply and  of  timber  traditional is  likely  sudden price hikes,  building  to  remain  materials, limited  and  such  as  cement,  subject  to  the  a concerted and organized effort to provide  alternative building materials is needed. Promotion of use of non-conventional materials,  like agro-industrial wastes can reduce cost of construction, and is  more environmentally friendly than traditional building materials.  For this,  tax concessions similar to those given to institutions engaged in scientific research should be given to  institutions  involved in research for alternate  and low-cost building technology. Several tax incentives and concessions have been given by the government to individuals and companies for housing, and their require  real value has  diminished due  re-examination with  concessions  and  introducing  a  view new  to  but to  they are of peripheral nature  inflation over  enlarging  fiscal  measures  the to  scope  the years. of  attract  These  existing  tax  private  and  corporate savings and expenditure on housing. HUDCO and NHB have been allowed to issue capital gains bonds , 91  capital gains are invested in bonds, 91  and this  or fixed deposits carrying preferential tax treatment  73  should contribute to a faster rate of growth of the housing finance sector . 92 invested in these bonds carries  The amount  a preferential  and if the sum invested was out of sale of capital assets, could be deducted from taxable capital gains. However, less attractive, as in 1992,  rate of  interest,  the amount invested  these bonds have become  the section providing exemption for capital gains  reinvested in capital gains bond was removed from the statute. The available  1992 to  Central  the  budget  housing  annual deduction of Rs.  withdrew  related  activities  3,600/-  fiscal  many  concessions  and house property  earlier  income.  The  allowable from the annual value of a house  property in respect of new residential units for a period of five years from the date of completion has been withdrawn.  The facility to set off loss from  house property against income from any other source was also withdrawn.  The  carry forward loss of any year from house property is now allowed to be set off only against income from house property of subsequent years.  The loss in  income from house property arises mainly from the imbalance between high rates of  interest  rental  payable  property)  on  This  .  housing  loans  imbalance  and  realization  persists  in  the  of  rent  initial  case  of  years  of  (in  10-12  borrowings whereafter rental income and interest payment match. Under the new provisions, period  to  the borrower would be required to wait for an inordinately longer avail  of  the  facility to  set  off  the  losses  incurred  in  earlier  years. This is likely to affect the level of future investments in housing. Total exemption from tax on capital gains arising out of transfer of a residential  house property where  the  total  and/or rate of interest. 92  Buckley et al,  (1989)  74  sale  consideration was  upto  Rs.  200,000  and  proportionate  allowed till 1992.  exemption  on  exceeding  sales  Rs.  200,000  were  Now these exemptions are withdrawn;  and residential houses  on sale are taxed for capital gains like other assets.  These concessions have  been withdrawn as a part of rationalization of tax laws; and their effect has been nullified to some extent by lowering of overall  tax rates.  However the  withdrawal of such concessions specific to investments in housing, now  the  housing  sector  competes  for  investment  along  with  means that  other  sectors.  Considering that less than 1% of the Indian population pay income tax, tax threshold is fixed at a very high level capita income of Rs.  10,000);  (Rs.  and the  35,000 as against annual per  the negative effect of such withdrawals will be  only on people in the upper-middle-income and high-income brackets.  In fact,  as the high income group have less of an incentive to invest in housing, price of housing may come down, low income groups. for  housing,  as  making it more accessible to the middle and  Also these groups will  the  rich will  the  no  longer  also have greater access to loans have  the  incentive  to  take  housing loans as the interest deduction from these has been limited,  large to Rs.  10, As of 1993,  one residential house is exempt from Wealth tax.  of houses are subject to payment of Stamp duty  Transfers  (at the rate of 3%);  capital  gains tax and gift tax like other assets. ny allowance received by the tenant for payment of rent is not included in taxable income. available  to  persons  living  in  their  own  house.  To  This deduction is not calculate  income  from  house property, annual value, which is the actual rent received or the sum for which the property can be rented for,  me 93  limit of Rs.  less property tax paid  5,000 for deductible interest has been raised to Rs.  75  (if rented)  10,000 in 1994.  is  taken  as  repairs,  the base.  Other deductions,  insurance  borrowed capital-  premium,  ground  upto Rs.  10,000  such as,  rent,  a  land  annually,  sixth of  revenue  and  annual  value  for  interest paid on  are allowed while computing the  taxable income. From allowed, public  business  income,  a  deduction  of  up  to  40%  of  total  income  for reserve created for investment in a financial corporation, engaged  company  in  providing  long-term  is  or a  finance  for  construction/purchase of residential houses. A deduction is also allowed in respect of part of the rent paid, of persons living in rented houses. 20% of payments made  (upto Rs.  A tax credit is available at the rate of  10,000)  for any installment paid for financing  purchase or construction of residential house property, loan,  in case  repayment of housing  stamp duty and registration fees. Property tax is the major instrument for mopping up unearned increases  in land values. tax  the  rates  land.  Most  and  vacant  The municipalities  charges,  in  areas  vary.  A  in  India administer a municipal property  few cities,  where  some  and is generally disputed. levied  at  as  Delhi  Town and Country Planning Acts improvement  development scheme by a public authority.  also  such  the  time  has  have  transfer,  Madras,  also  tax  specified betterment  been brought  about  through  a  This is a difficult levy to assess  A tax on unearned increase of  and  the  in property prices  principle  being  that  half  is the  appreciated value be recovered by the public authority . 94  94  Ribiero,  (1985). The stiff penalty is imposed to prevent people from profiting by sale of them at concessional rates by the government. However, this is generally  property allotted to  avoided by understating the resale price- resulting in a double loss for the government- loss of stamp duty (calculated as a percentage of the sale price); and creation of black money (through unreported income)  76  In India, ways.  owner-occupiers and private landlords are treated in similar  However,  in terms of tax relief,  lower return on their investment,  residential property investors get a  as their income,  whether actual or imputed,  is subject to lesser allowances than business investments. For example, of business  case  assessment,  interest paid,  depreciation and other expenses  incurred are fully deductible; while from house property income, is not allowed, rent etc.  are  and expenses such as interest, subject  to ceiling limits.  in the  repairs,  depreciation  cost of collection of  Moreover while business  losses are  allowed to be set off against other incomes of that year and subsequent years, from  losses  house  income  against  property  income  are  restricted  and  can  from house property in subsequent years.  be  This  set  off  only  discriminatory  treatment of house property income reflects the thinking that house property is not  income but  fully reflected in monetary terms of earned or imputed rents,  return  the  of  house  property  also  includes  intangibles,  security and status obtained from owning a house.  satisfaction,  such  the  as  Rents in the  India are not a reflection of the value of the property, as the rate of return is low, The  but the capital gains realized on transfer of property are very high.  only  tax  counterparts spent  towards  advantage  is  that  house-owners  they can  purchase or  in  claim a  India  tax credit  construction of  the  incentive is not regressive among tax-payers, not deducted from the taxable income,  have  over  for a part  house.  The  of  business  the amount  incidence  of  this  as the amount of investment,  is  but a tax credit at the rate of 20% is  . 95 given  Clearly this  housing,  rather than consumption and other business assets.  step is  their  in the direction to encourage  However, non-tax payers, do not get any tax credit refund.  77  investment into  Revisions earned  the  to  certain  on  income  deposits;  tax  code  24(i) (vi)-  (Sections  80L-exemption  deductibility  of  of  interest  interest  paid  on  housing loans; and 80CC- exemption of amount invested in the equity of certain companies) would make certain deposit services offered by HFIs more attractive to their customers, of  tax laws  thereby enhancing their ability to raise funds . 96  that affect  the distribution of  financial  savings  very important to a firm’s ability to mobilize resources. complicated and difficult to evaluate in isolation. e.g., upto Rs.  7,000 per year,  paid on deposits of upto Rs  institutions are eligible for tax deduction, eligible for another Rs 3,000 deduction NHB had announced in  1991,  in  The set  India are  They are also very interest earnings of  140,000 with financial  while deposits with the UTI are  97  a Voluntary Deposit Scheme for mobilization  of black money 98 and its partial use for construction of houses for the poor. Under this scheme 40 percent of the total collection of over Rs.  800 million  are available for providing housing for the poor. Though the final outcome of this scheme in terms of the actual numbers of housing created for the poor is yet  to be evaluated,  housing  stock  the theory of utilizing black money for augmenting the  innovative  is  and  useful  as  it  proposes  to  bring  about  re  distribution of income. Few  Indian  suckley et al, 96 Buckley et al 97  families  have  to  concern  themselves  with  tax  provisions;  (1989) p 23. (1989) p 24.  Black money is the income not reported for tax purposes. The Voluntary deposit scheme was 98 an  amnesty program  deposited  in  the  for  one  year,  to  notified account  penalty or interest was charged.  allow declaration of  with NHB,  were  taxed at  hitherto the  unreported  highest  income.  marginal  rate,  ?unounts but  no  Similarly no questions were asked regarding the source of the  income.  78  since most household savings are of a size not affected by tax provisions. For access  to household savings  the most  important  taxes  are not  taxes  at all.  They are the implicit regulatory “taxes” that affect and constrain return and maturities of deposits and the ability to provide various types of financial services on a monopolistic basis;  life insurance.  e.g.  The effects of these  kinds of taxes are very difficult to infer . For the allocation of savings of 99 corporations  and  considerations  the profitability of  are more  important.  competing  However,  financial  institutions,  as Buckley et al  (1989)  tax  report,  they are no less difficult to evaluate. This  complicated and multi-layered environment  answer quantitatively questions such as, for ensuring housing financial Or, and  makes  it  impossible  to  which tax regulations are essential  institutions  success  in mobilizing resources.  which tax code provisions favour the sector at the expense of the economy vice  versa?  However,  by  the  same  token  it  is  obvious  that  such  a  complicated tax code is not in the best interest of either the housing sector or  the  financial  provision reformed  system.  analysis  of  Hence,  relevant  comprehensively  and  rather than trying tax  provisions,  consistently,  reform.  Buckley et al, 99  (1989)  79  to perform provision by  taxation  along  with  issues broader  need  to  be  financial  CHAPTER SIX  HOUSING TAX EXPENDITURES IN OTHER COUNTRIES Housing tax expenditures in countries other than India are discussed in this  chapter.  Section  6.2,  Sections  6.3  6.1  describes  and 6.4 discuss  the HTEs  used  their presence  in OECD  countries,  in Britain,  while  Canada and USA  respectively. 6.1 OECD Countries It tax  is  difficult  expenditures  countries.  given  the  variations  actually constitutes housing  in  taxation procedures  OECD member countries may be divided into 2 groups . 100  corresponding reliance  (HTE)  to generalize about what  on  to  English  direct  speaking  taxes  applied  countries, to  income  are and  characterized profits.  The  in OECD  The first, by  a  heavy  second  group  exhibits a high ratio of indirect taxes on goods and services to direct taxes, and relatively higher social Greece) assets,  These  .  differences  security contributions. are  reflected  in  the  (e.g.  tax  Spain,  treatment  France and of  with the former group placing a greater reliance on taxes  housing  levied on  housing returns, and the second group concentrating more upon taxes applied to transactions in housing assets and recurrent property taxes. The most common HTE5 afforded for housing construction are exemption of profits from corporation tax or granting of preferential tax allowances to the producers of low to medium income housing. Reduced indirect tax rates, Value Added Tax countries  income  corporation  tax.  (VAT), from The  are applied to the sale of new housing. rental  housing  preferential  is  subject  treatment  of  to  personal  deductible  00 discussion of fiscal policies in OECD countries is based on Wood, ‘ The  80  such as  In most OECD income  operating  1990.  tax  or  costs  constitutes a principal source of tax expenditures for rental housing. housing  is  also  exempted  from  (or  is  subjected  to  lower  rates  Rental taxes  of)  applied to real property, and transfer duties. Tax expenditures are a key component of most OECD governments’ policies to promote home ownership. HTEs for home ownership-saving schemes are deployed either through tax-free interest and bonuses, or deduction of savings deposits from taxable income. of  In the taxation of imputed housing income and deduction  owner-occupiers’  deducted  from  income  some  occupier’s OECD  for  income  countries  expenditure  on  most  countries  tax purposes,  allow mortgage  though  ceilings  interest  and  to  conditions  be are  The addition of the property’s imputed rental value to the  generally applied. owner  expenses;  is  in  less  common.  respect  of  saving,  energy  Tax allowances  expenditures,  repairs  and  such  are  also  as,  property  improvement  invoked by taxes,  expenditure  and  depreciation. The taxpayer’s main residence is generally exempted from capital gains  tax.  However,  this  can be  subject  to  various  conditions  such  investment of the sales proceeds in the purchase of a new residence,  as  re  and the  length of occupation. The  taxation  of  owner  occupiers’  imputed  net  rental  income  entails  logistical and political problems. Notional rental income values are based on administered costs.  assessments  that  Since assessed values  require  significant  and  enforcement  are generally below market values,  and current  expenses are commonly accorded tax allowance status, to be low.  the revenue yield tends  It is also difficult to politically justify the “fairness” of a tax  levied upon an intangible income stream. governments  policing  of  United  Kingdom,  France,  Prompted by these considerations the Ireland,  Australia  have abandoned the taxation of imputed net rental income, 81  and  West  Germany  even though some of  them  continue  treat  to  United Kingdom,  current  housing  expenses  as  tax  allowances.  the  owner-occupiers receive tax relief on their mortgage interest  payments at their highest marginal tax rates on the first mortgage.  In  Under  the  Mortgage  Interest  Relief  at  30,000 pounds of a  Source  (MIRAS)  scheme;  households not liable for income tax make mortgage payments net of “relief” at the basic rate of tax.  In West Germany the owner-occupiers can take  advantage  of a depreciation allowance that amounts to five per cent of the historic cost of purchase in each of the first eight years of ownership  (the allowance is  only available once and the accumulated aggregate cannot exceed DM 300,000). The United States grants generous allowances to home owners. In contrast, in Denmark,  Finland, imputed  Generally, assessed  the imputed net rental income of owner-occupiers is taxed  capital  frequently  Greece, rent  value,  employed,  is  Luxembourg, arrived  at  generally  further  the Netherlands, as  a  below  reducing  the  percentage  market impact  Spain and Sweden. of  values. of  tax  current expenses are deductible from assessable income,  the  property’s  Exemptions  liabilities.  are Since  imputed net rent can  often be negative in the initial years of ownership . 101 OECD governments have introduced provisions designed to place a ceiling on mortgage  interest relief.  However this  is matched by the introduction of  new tax expenditures designed to promote new housing construction and housing improvement and repair.  101  Finland typifies  taxation provisions in this  respect.  Since  1973  Finnish home-owners  have been subject to the payment of income tax on net imputed rent. The gross imputed rent is set at  3 per cent of the administratively assessed capital value,  which normally lies below market  values. Those properties whose assessed capital values is below 215,000 Finnish marks are exempt. Home owners subject to tax, and up to 25,000 marks  can deduct annual mortgage interest payments in excess of 600 marks  from gross imputed rent.  owners were taxed on net imputed rent in 1983.  As a result,  (Wood,  82  1986).  only 2 per cent of Finnish home  In  some  OECD  countries,  tax  expenditures  are  explicitly  granted  to  private landlords in order to encourage their acquiescence with rent controls. Since  rent  result may  levels,  rent  these  tax  arrangements  in losses being incurred during the early years of  be  deducted  represents there  depress  controls  from  other  sources  an attractive means  is positive  taxable  of  income  of  income.  sheltering  This  other  from rental  investment, “negative  sources  housing,  normally  of  which  gearing”  income.  When  owners may avoid tax  entirely on housing returns by taking advantage of the exemption of capital gains from taxation, which becomes available after a minimum possession period of two years. Most OECD countries treat the capital gains realized on owner-occupiers’ residences  principal  as  exempt  from  taxation.  In  taxed,  deferral provisions nullify their effect.  owners  can defer taxes  home.  There  $125,000,  is  also  a  if  countries  For example,  the realized gains are put  one-time  capital  for owners aged 55 or more.  gain  where  up  are  in the US home  into a more  exclusion  they  to  a  expensive ceiling  of  In Sweden capital gains are also subject  to taxation on a deferred basis,  provided they are re-invested in the owner  occupiers’  In  principal properties,  principal residence  residence. are  exempt,  Canada while  capital  in  gains  respect  of  other  to the use of nominal  of  residential but 25 of  or real  but the practice varies in regard  capital gains as  the tax base.  real capital gains are taxed under income tax provisions. (TRA),  sale  In most OECD countries capital gains realized on private  rental properties are subject to taxation,  Act  the  income tax provisions apply to realized nominal gains,  all gains are exempt.  Reform  from  the  US  subjected  the  realized  nominal  In Australia,  Until the 1986 Tax capital  gains  of  private landlords to a preferentially low tax rate. Taxation provisions differ 83  in Germany where capital gains are entirely exempt beyond a minimum possession period of 2 years. All European community countries except Denmark and Britain have local taxes on property.  Britain has a business property tax but abolished domestic  rating in  favour of a Community Charge or Poll Tax.  “domestic  tax,”  was  scheduled  to  replace  the  A new system,  Community  Charge  called a in  1993.  Recurrent property taxes are levied by local tiers of government in almost all OECD  countries.  have  been  The  tax base  assessed  for  tax  generally consists purposes,  and  of  the  land and buildings tax  is  levied  at  rates  established by municipal government revenue needs. As the tax is local, is  variation  wide  in  assessment  countries. Some countries,  procedures  such as USA,  both  within  and  that  there  between  OECD  allow deduction of property taxes from  assessable income under federal tax provisions. Greece  is one of the  few countries  to include residential property in  the tax base of a recurrent wealth tax introduced in 1982. vociferous  public’s  reaction,  the  tax  rates  have  apply to administratively assessed capital values  been  In response to the  reduced  sharply,  and  that are deliberately kept  below market values. Thus the impact of this wealth tax is negligible. Examples of non-recurrent taxes are the stamp duty levies in Australia and UK,  and the transfer taxes payable in Greece and Portugal. Home owners in  Greece are subject to a number of non-recurrent indirect taxes many  tax  expenditure  provisions  apply.  The  NRIT  comprise  transfer tax applied to the sales of residential property, /gift  tax  inheritance,  that  is  applied  to  the  transfer  gifts and parental assistance.  of  a  to which  real  estate  and an inheritance  property  Since 1982,  (NRIT)  by  means  of  an  the tax base has been  valued in both cases by administered methods resulting in below market values. 84  Similar tax provisions with significant NRIT on residential property are also found in Portugal, In Canada, the  tax  Spain and Turkey.  France,  treatment  of  Germany,  Japan and Luxembourg an important aspect of  home-owners  is  facilitate down-payment requirements. towards  $20,000  upto  In France,  allowance.  a  first  use  of  accumulated  Plans funds  tax  expenditures  Since 1988,  savings  post offices,  to offer Housing Savings the  home  the  accorded  to  USA allows contributions of  account  to  be  treated  as  a  tax  savings banks and trading banks are able  that grant for  the  tax-free  interest,  purposes  of  conditional on  acquiring  residential  property. British,  The  Irish  and  specialist Housing Finance provisions.  US  governments  Institutions  The aim of such measures  is  (HFI5)  have  traditionally  by means  protected  of preferential  tax  to bring about greater stability in  the flow of mortgage finance. The specialist US savings and loans institutions (S&Ls)  were originally exempt from federal income taxation. This exemption was  removed in 1951 and replaced by a tax allowance for bad debts, tax rate provision. more  of  their  This enabled S&Ls to avoid paying taxes,  total  assets  were  held  in  home  mortgages  and a maximum  provided 82% or  or  US  government  securities. Less  common  among  OECD  countries  is  the  use  facilitate the issue of mortgage backed securities.  of  tax  In the US,  government are entitled to issue mortgage revenue bonds,  expenditures  state and local  that are tax exempt,  and the revenue can be used to fund below-market interest rate mortgages, the construction of low-income rental units. time buyers,  on low to moderate incomes,  distressed” areas. 85  to  or  Mortgages are targeted on first  who are purchasing in  “economically  to  Resistance  taxation  imputed  of  represents an “invisible” income stream. tax base measured in nominal terms, wealth.  rents  is  on  the  ground  that  it  In an inflationary environment with a  taxing imputed rent becomes a tax on real  This problem is particularly sensitive issue with respect to housing,  as housing equity generally forms  the largest  component of many households’  net worth. Table occupiers  6.1  describes private  and  the  features  chief  landlords  in  some  of  OECD  the  taxation  countries  and  of  owner  India.  The  Australian and Canadian tax treatment of housing assets differs according to whether  they  are  owner  occupied  generating consumer goods), investments gains  and  and the  taxed  or privately rented  accordingly)  imputed  net  they  (when  .  rental  UK,  are  of  as  non-income  (treated as income generating  Ireland  income  treated  and  France  exempt  home-owners,  while  capital allowing  deduction of mortgage interest payments which is inconsistent with the normal tax treatment of either investment assets or as  consumer goods.  Thus,  home  owners are unambiguously granted preferential tax provisions as compared with private  landlords.  In practice,  the  same  situation prevails  in USA,  as  the  deferred basis of taxation of capital gains and a generous one time exemption means  that  most  home-owners  do  not  incur  a  liability.  The  Netherlands  and  Sweden are distinctive in having a consistent and more tenure-neutral set of tax provisions,  treating  housing  assets  mainly as  investment  goods.  also treats both landlords and owner-occupiers in a similar manner, not levying any wealth tax on owner-occupied houses.  86  India,  except for  Table 6.1:  of Owner-”.’ 1 and  P--,,r, —--.-,-  -.-‘-‘-  D,l-1  U,,.,,.r  in -  1nt-1  T,-.-I4 ‘-‘-.----nd  —-  OECD Countrt Prefere ntial tax treatment to savings  Transfe r Tax or Stamp Duty  INDIA  Both  Both  AUSTRALI A  None  Both  CANADA  None  Both  Finland*  No Owneroccupie rs None No Both  No  Country  FRANCE  GREECE IRELAND*  Allow Deducti on of Mortgag e Interes t Both  Tax impute d / Net Rental Income  Tax Capital Gains  Annual Wealth Tax  Recurrent Propert y Tax  Both  Both  Both  Landlords Landlords  Landlords Landlords  None  Both  Yes Both  Yes Landlords  Landlords Landlords No  LandlordB None  No  None  Both  No Both  Yes Both  Both Yes Both  Both No Both  None No None  Both No Both  None No Both  Landlords Landlords Landlords  Landlords  None  Both  Landlords  None  Both  None  Both  Both  Both  Both  Netherlands Sweden  None  Both  Both  UK  None  Both  Both  USA  None  None  Both  Source: Adapted from Maclennan and Williams from The Indian Income Tax Act, 1992. * Relating to owner-occupiers only.  (1990).  Both  Information about India is  The Greek housing tax provisions are distinctive and are representative of  that  social  group  countries  of  security  levies.  which  Though  rely  both  more  heavily  homeowners  and  subject to the same array of taxes on housing assets,  on  indirect  private  taxes  and  landlords  are  home-owners are granted  significant tax allowances and part exemptions. Recent  reform measures  subsidy provisions  towards  a  in  OECD  tenure  have  not,  neutral  provisions introduced in recent years reflect  87  in  general,  subsidy/tax  changed  system.  housing  The new tax  concerns ranging from the cost  of tax expenditures,  to using tax expenditure provisions  particular purchasers,  in order to  favour  activities or segments of the housing stock.  Measures designed to curb foregone tax revenues have a disproportionate impact on high income groups,  as  use  02 countries’  of  allowances.  tax  Some  they generally  preclude  allowances at the tax payer’s marginal rate. 1988,  restrict  the  tax benefit  involve limitations on the the  In Greece,  from mortgage  application  of  tax  reforms introduced in  interest  tax allowance  to  the  base of the income tax rate scale.  Similar flat rate deduction provision has  been employed in France since 1983,  with rebates on mortgage interest charges  calculated at the flat rate of 25 per cent.  The introduction of a ceiling on  the extent of allowable cost deductions is increasingly common. adjusted  in  line  with  inflation  the  real  value  of  tax  If this is not  allowances  will  be  gradually eroded; resulting in a convenient way of phasing out tax allowances. Tax  credits  are  also  used  to  both  curb  the  cost  of  tax  expenditures,  and  ameliorate their regressive nature. The  situation  regarding  fiscal  policies  that  OECD countries that publish tax expenditure budgets,  affect  housing  in  three  and where such policies  have been studied and analyzed is discussed next. 6.2 BRITAIN “Housing in Britain is the subject of a web of subsidies, benefits, and tax concessions; which has grown steadily more tangled as the years have gone 103 by.” In magnitude.  WOOd 102 103  Hills  Britain,  housing  as  an  economic  sector  has  It represents 4 per cent of national output;  (1990)  (1991)  p 3.  88  a  very  significant  housing construction  employs a million people and housing makes up a fifth of the gross investment in  fixed  in  capital  the  economy.  It  has  been  recognized  that  the  housing  market is driven by economic change, particularly in terms of incomes,interest rates and household formation . 104 T11  6.2:  i,  Housinci and Other  TTV  Interest payments Owner-occupiers  Interest tax deductible No Interest Relief No Interest relief No Interest relief  Other Business Investment Other consumption equity  Personal plans Pensions  Shares  No relief No relief  Building society and bank accounts Source: Hills  Return ( cash! imputed) Tax-free imputed rent Rents taxed-no deduction for depreciation Income taxable  Tax-relief upto 30,000 Interest is tax deductible  Private Landlords  Interest interest  Ti,r’,,m  Capital gains Tax-free Real taxable  Gains  gains  No Tax  Real taxable No tax  No Tax  No Tax  Advantage from contribution relief and taxfree lump sums Dividends taxed  Not applicable  Nominal Taxed  return  Real gains taxable Not applicable  (1991)  In Britain,  owner-occupiers were treated originally in a way similar to  private landlords. The return on their investment, the imputed rent was taxed, after  deduction  costs.  Over the years the tax system changed,  position of taxed,  of  expenses,  owner-occupiers.  including  Their  interest  payments  and  maintenance  resulting in improving the tax  imputed rents  and  capital  gains  are  not  and they also receive tax relief on the first 30,000 pounds of their  mortgage.  Private  nor set off  landlords  cannot  deduct  depreciation or  losses on property income against  Maclennan and Gibb, 104  (1993)  p 12.  89  income  imputed expenses,  from other sources  for  tax purposes-  thus  owner-occupiers.  having  a  Housing is  spending by owners  disadvantage  over  other  largely free from VAT,  and landlords  on  improvements  businesses,  although it and repairs.  as  is  well  as  charged on  Stamp duty  is  charged at 1 per cent of any transaction of 30,000 pounds or more. Table 6.3:  TAX SUBSIDIES TO OWNER-OCCUPIERS IN UK Mortgage Interest Relief 191 126 284 300 405 440 488 748 888 1002  Gross Annual Income Band 600 2600-5199 5200-7799 7800-10399 10400-12999 13000-15599 15600-20799 20800-25999 26000-31199 31200> Source: Maclennan and Gibb In MITR-  Britain,  capital  home-owners  Interest  Mortgage gains.  (1993)  MITR  Imputed rental Income Tax 105  Real Capital Gains Tax  417 291 306 291 290  3455 2645 2937 2499 2888  308 375 605 619 608  3078 3456 4699 5545 4330  p 20.  receive  Tax Relief;  rises  Tax  (Pounds)  several  tax  subsidies  and non-taxability of  steadily with  income.  The  in  the  imputed  form  rents  of and  subsidy associated with  imputed rents is governed by the length of residency and outstanding mortgage debt,  therefore its pattern is less clear with respect to income.  of a capital gains tax,  benefits higher house price areas and does not have a  particularly strong relationship with current incomes. fail and  to  provide  sometimes  a progressive  arbitrary  The absence  and  distribution of  in  no  way  can  be  Overall,  subsidy, said  to  tax subsidies  they are confirm  inefficient to  rational  imputed rental income tax is the tax that would be levied on the net equity owned by the 105 it is net of debt which receives MITR. The exemption from real capital gains tax  household,  refers to the taxable gain made after allowing for inflation, a pound 5000 allowance and assuming sale in 1988 and original purchase in 1982.  90  housing policy objectives . 106  Table 6.3  shows  the  regressive nature of tax  subsidies received by owner-occupiers. The  level  of owner occupation in Britain has  last 40 years rising from 3 million dwellings 15.4 million dwellings rapid house pounds  price  5,000  to  (67% of households)  60,000-  an  of  increase  (31 % of households)  in 1991.  inflation with national  increased rapidly in the  average  1,100  per  Since 1970,  in 1951 to  there has been  house prices cent.  These  rising two  from  trends,  expansion of home ownership and rapid house price inflation, have led to major changes in the role of owner occupation in personal wealth holdings. The value of dwellings as a proportion of all net personal wealth increased from 18% in 1960 to 37% in 1975 and 52% in 1989107. Value-added-tax the domestic economy.  (VAT)  is a method of taxing final consumer spending in  It is a multi-stage tax that falls on all final consumer  goods and services, except those that are explicitly exempted. New building is exempt from VAT,  presumably on the grounds that housing,  zero-rated items, The housing  tax  is a necessity.  and  tenures.  like other exempt or  subsidy The  owner  system  in  occupier  Britain  discriminate  markedly  receives  tax  mortgagor  25%  between  relief  on  interest payments on the first 30,000 pounds of their mortgage.  As an asset  holder,  a  owner  they are  occupiers  outright owners,  exempt do  not  from capital pay VAT.  Low  gains income  and  income  owner  tax.  occupiers,  As  consumer,  borrowers  and  have no recourse to income-related housing benefit which is  restricted to tenants. Mortgagors who qualify for income support can, however,  106  Maclennan and Gibb,  Hamnett and Williams, 107  (1993) (1993) p 137.  91  get help with their interest payments. housing where  benefit,  a  rent  therefore  although  officer  eligible  for  this  can  is  Tenants on low income are eligible for  restricted  determine  benefit  in  whether  expenditure.  the  the  Social  private  rent  is  sector  rented  sector  reasonable  tenants  and  may also  receive some sort of price subsidy through mediation from central government and also implicitly through historic cost accounting and rent pooling. Evidence suggests that formal subsidy to owners, outweighs that received by tenants that  HTE5  . 108 M1TR  at are  relatively low household regressive,  Further,  HTEs,  e.g.  the  incomes  top  third  (5000 of  pounds  owners  per annum)  receive  in the face of inelastic housing supply,  2/3rds  and of  are probably  capitalized into higher house prices with implications for the cyclical nature of the housing market. 9’h1  4.  T’innni1 iihi+v by Tpniir ii, TTIC Local Authority Private Rented  Ma-h,  P’rn-mq rf  Owner occupation Mortgage Tax Relief at source (MIRAS) Non-taxation Imputed rent Capital Gains  Housing Revenue  Housing Benefit  Account Subsidy  Improvement Grants Landlords  of and  Housing Association Housing Association Grant Housing Benefit  to  Housing Benefit Improvement Grants  Business Expansion Scheme Tax  Council Houses Benefits Sales Discounts Source: Willis and Cameron (1993) p 54. Willis and Cameron (1990) and  Housing  108  Rent  Assistance  Hamnett and Williams,  show that while the amounts of housing benefit (HRA)  decrease  (1993)  92  with  rising  income  bands  (no  housing benefit for people having income over 13,000 pounds p.a., for  incomes above 10,400 pounds p.a.);  and no HRA  MITR increases with income,  with the  largest increase happening when income moves from pounds 20,800-26,000 income band  26,000-31,200  pounds  to  strongly progressive, while MITR is highest  income  income  going mostly to  strongly regressive, groups.  average benefits  band.  In  Means  renters  in  tested the  housing  lowest  benefit  income  is  groups,  giving the most benefits to those in the  between,  the  lower  to  average  income  bands  have  from financial subsidies which are substantially lower than  those at upper and lower extremes on the income groups. The Business businesses  Expansion Scheme  in raising capital  109  .  .  in the year they buy shares of  (BES) .  set up  was  Individual  in  1983  to assist new  .  investors get income tax relief  companies raising funds under the BES.  shareholder retains the shares for at least five years,  If a  no capital gains tax  is paid on chargeable gains realized by any subsequent sale of the shares. 1988,  the benefits under the BES were given to assured tenancies also.  estimated that during the first 2 years,  BES  stimulated a  It is  544 million pounds were raised and  almost 10,000 properties would be acquired from these funds. years  In  In its first two  supply of new and higher standard rented housing  in  locations where private renting was not usually found and which had been let to a wide range of tenants. Just over one half of BES tenants said they found it easy to afford the rent. private  rental  directors  housing  that  The BES has resulted in an additional supply of would not  otherwise  have  created.  Company  said they could not have raised money for private renting without  this or some other subsidy.  109  been  This discussion is based on crook and Kemp  93  (1993),  p67-85.  Preliminary evidence suggests that the long term impact of BES is likely to be negligible.  Most companies did not think they had a long term future,  and perhaps would ultimately sell their properties into owner occupation and wind up the company.  Few of them thought that they could raise funds without  subsidy under the current housing finance system because rents did not give a competitive return. term finance.  The returns from rents were insufficient to attract long  In the view of the company directors tax breaks  or some other  subsidy are needed to make returns from rental housing attractive. Table  6.5  summarizes  and  compares  the  housing  subsidies  taxation  and  benefits applicable to owner-occupiers and the private rental sector in UK. Tl1,1  --..-——  . -  Wq-h, ihqir1i, --————--,  -.----——--——-.-  Ti-t,i, -------——.  i-ir1 fi-c —--  n TTV  OWNER-OCCUPIERS PRIVATE RENTED SECTOR Taxation of landlords: -rents taxable -Interest deductible -Capital gains taxed -No depreciation allowance expansion -New Business concessions -Stamp Duty charged Rent Regulation  Taxation: -Imputed rents not taxed relief -Tax on first mortgage (MITR) -No Capital Gains Tax  of  Scheme -Stamp Duty charged Insulation grants Improvement grants Income support payment of mortgage interest Rates net of housing benefit from VAT for Exemption (except repairs and improvements)  Improvement Grants Housing benefit for tenants’ rents (rent rebate! allowances) Rates net of housing benefit Exemption from VAT (except for repairs and improvements) Source: Hills, Berthoud and Kemp  30,000  (1989) p 2.  6.3 CANADA  In Canada, furnishings  and  housing is the most costly item in most people’s budget. household  expenses  such  94  as  heat  and  property  taxes  If are  included,  it  homeowners,  on  absorbs,  average,  almost  25  of  household  . 110 income  For  the dwelling generally is the household’s largest capital asset.  The various forms of housing assistance available in Canada are listed in Table 6.6.  The scope and range of this assistance is enormous-  for 1979,  the major federal expenditures for housing assistance were in the range of $ 8 . 1 billion  Almost 80 per cent of federal housing expenditure is in the form  of tax expenditures. Table: 6.6 Ma-ior Federal Expenditures for Housing in Canada. Subtotal* Type of Expenditure CMHC grants, contributions & subsidies: social housing (public housing, non-profit housing, cooperative housing etc.) housing market ARP, interest (AHOP, forgiveness) land assembly & municipal infrastructure community relations other Implicit interest subsidies on outstanding loans Implicit subsidies in NHA** insurance fees Federal Tax expenditures: non-taxation of imputed net rent non-taxation of capital gains RHOSPs MURBs Rent control costs Total non-capital items CMHC commitments for loans and investments Total federal housing assistance expenditures  1979. Total* 840  288 52 130 133 237 100 15 6360 3,700 2,500 115 45 225 7540 350 7890  Source: Smith (1981) p 455. * $ millions ** National Housing Act The  affordability  of  accommodation  and  profitability  of  the  housing  sector have been a major preoccupation of governments in most OECD countries. In Canada,  as in the USA,  Statistics Canada, 110 Smith, 111  (1981)  (1989),  reliance on private sector housing is greater than  as reported in Harris  p 455.  95  (1991)  in  countries  most  espoused  than  more housing  social  of  Europe.  rental  Similarly  . 112 housing  expenditures  were  home  During  ownership the  controlled  is  ideologically  recession  but,  in  restraint  1973-1985, in  direct  expenditures was offset by HTEs for private-sector housing. One reason for the difference  in  affordability pressures  treatment  was  for  middle  the  the  necessity classes  to  in  offset the  housing  subsidies  direct subsidies and loans.  context  (nonprofit  and  of  cooperative)  In addition to these,  problem  of  recessionary  Home Ownership Saving Plan program.  MURB  (RHOSP)  involve  such as the Registered  and the Multiple Unit Residential Building  mainly helped developers  and  investors.  such as the Assisted Home Ownership Program  Rental Program (ARP)  usually  home ownership and private  rental housing are subsidized through tax expenditures,  programs,  rising  113  Social  (MURB)  the  (ABOP)  Direct  subsidy  and the Assisted  accounted for a smaller portion of these expenditures.  For the ownership sector, AHOP was expanded and RHOSP was introduced “to assist young people in accumulating the capital required for a down payment on a house”  and as a means  for providing  “an important new source of mortgage  funds to finance the construction of new housing we require”. rental  sector  the ARP was  For the private  initiated and the MURB tax provision  introduced,  creating a tax shelter for wealthy investors by permitting capital allowances on new rental projects to be written off against other income . 114  By  maintaining  112 Lithwick,  RHOSP  and  MURB,  (1985)  Hulchanski and Drover, 113 114 Hulchanski and Drover,  (1987) p 53. (1987)  p 58.  96  future  middle-class  home  owners  and  individuals  wealthy  in  the  top  tax bracket  housing investments in spite of restraint.  retained  the  subsidies  on  their  RHOSP helped address the high cost  of becoming a home owner and MURB addressed the lack of profitability in the private rental sector mainly  115  Tax expenditures in general,  .  benefit  the  higher-income  the  HTE  benefit  greater  is  households.  received.  HTEs  The  are  and HTEs  greater  not  in particular  one’s  only regressive,  also many times greater than direct spending programs on housing In most other budgetary categories, spending  is  just  the  opposite:  the direct expenditures.  higher  income  groups  assistance was 6.8  and  6.9  As more was  it  is  this  pattern  for persons  are  less,  but  (Table 6.6).  that  more  federal  earning higher income.  of  expenditure  resulted  in the higher income quintiles,  -“--.--  6.7  P(R1  T  --—-.  Tv  ir4-11rQq  -.—  Income Group Under $5,000 5,000-10,000 10,000-15,000 15,000-20,000 20,000-25,000  As in  housing  tables  6.7,  higher  home  while persons  1q79  Average HTE benefit per tax filer $32 171 314 619 964 1312 1994 3670 6753  25,000-30,000 30,000-50,000 50,000-100,000 $100,000 and over Source: Hulchanski and Drover  Hulchanski and Drover, 115  in Crt4  (1987)  p 64.  (1987) p 62.  97  per  which benefitted  the lower income quintiles shifted towards rental housing. m1-,1:  are  between 30-50  spent on HTEs,  inevitable  received by the persons  depict,  ownership rates  more,  the  the relationship between the two types of  tax expenditures  cent of  income,  in  6.8 Changes in Home-ownership Rates in Canada Percentage of households owning their house  Table:  Income Quintile  1967  1973  1977  1981  Change 1967-81  Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile TOTAL  62.0 55.5 58.6 64.2 73.4 62.7  50.0 53.6 57.5 69.8 81.2 62.4  47.4 53.3 63.2 73.2 82.3 63.9  43.0 52.4 62.7  -19.0 -3.1 +4.1 +10.8 +10.1 +0.6  Source: Hulchanski and Drover Table:  75.0 83.5 63.3  p 65.  (1987)  6.9 Changes in Renter Households in Canada. of households renting  Income Quintile  1967  1973  1977  1981  Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile  20.4 23.9 22.2 19.2 14.3  26.6 24.7 22.6 16.1  29.1 25.9 20.4  31.1  Source: Hulchanski and Drover In recent years, the  moneys  regressive: affluent, all.  Thus,  promoting  on  spent owners  (1987)  to owner-occupiers  housing”.  are generally more  living in the largest homes, the poor are home-ownership  The  immediate  affluent  than  been  have  far out-weighed  effects  tenants,  are  socially  while  the most  have received the greatest subsidies of  in effect subsidizing the rich. has  -5.6 -5.3  9.0  p 67.  tax subsidies “social  26.0 20.3 13.6  14.8 9.8  10.0  Change 1967- 81 +10.7 +2.1 -1.9  to  bolster  the  The larger effect of  developing  economy  by  boosting the demand for goods and credit. In Canada policy providing has been chosen over modest This  choice  has  left  a  sustained  deep,  subsidies  to  small  numbers  subsidies spread over a larger number of people.  large  number  of  98  low-income  Canadians  with  serious  affordability problems  116  6.4 United States of America Even recently,  though  the  USA,  in  the  tax  activities since the first amendment  non  code  tax  expenditures  has  been  used  In 1913,  deductions  taxes on homes owned by taxpayers,  business  state  was  developed  relatively  to  subsidize  particular  income tax law enacted after adoption of the  to the Constitution.  state and local some  of  concept  and  local  taxes,  for mortgage  interest and  as well as deductions  were  . 117 allowed  Thrifts were legally required to invest  they devoted 80 of their business to this, Thh1 —  -  1O Ma-ior —  flS__LVLL_L  by Thx  in TTA•  1. Retirement 2. Home ownership mortgage interest Property taxes Capital gains treatment Subtotal 3. Health and health insurance 4. Municipal Bond interest 5. Investments 6. State and Local Taxes 7. Charitable contributions 8. Capital gains at death 9. Other Activities Total: all Tax Expenditures  87.0  (1991)  Lithwick, 116  (1985) p 53.  Peterson, 117  (1991) p 61.  118 Iarn and Wolman,  $  19fl — —  of total 27.9  25.4 8.1 13.7 47.2 44.4 20.7 18.4 19.2 10.5 5.4 59.5 312.3  p 61.  (1992)  in housing loans;  -—  Billion  Peterson  p 102.  99  from  they received tax exemptions . 118  Activity  Source:  for  Government  intervention to strengthen the supply of housing credit in the US dates the Depression.  16th  15.1 14.2 6.6 5.9 6.1 3.4 1.7 19.1 100.0  if  Table  6.10  shows  that  among  the  activities  expenditures, housing gets the second largest subsidy.  subsidized  tax  by  The details of  housing  tax expenditures for individuals are given in Table 6.11. Th1  -  1 1  Wciii na  Deductibility mortgage interest owner occupied houses  xrndi t-iir  of on  frr  TricIi ri ii1  In  rT  ($ millions)  1983 25065  1984 27945  1985 30130  1986 32785  1987 35305  1988 37,950  8765  9535  10480  11710  13215  14980  450  485  475  445  415  385  285  355  430  510  585  665  3770  4895  5625  6000  6480  7030  1255  1630  1875  2000  2160  2345  -  Deductibility of on property tax owner-occupied houses Exclusion of interest state on and local government housing for bonds owner- occupied housing Exclusion of interest state on and local government for bonds rental housing Deferral of capital gains on home sales Exclusion of capital gains on home sales for persons 55 age and over  Source: Modified from Surrey and McDaniel  (1985)  7-14.  p.p.  A comparison of tax expenditures and income transfers shows that in the fiscal times the  year  overall  transfers  (that  greater than tax expenditures. few  transfer  activities, spending.  commerce is to  1989,  transfer  where The  dollar  103.7 billions spending  of  tax  is  However,  expenditures value  of  tax  direct  expenditures)  2.5  were  housing and commerce are among were  many  times  expenditures  for  larger  than  housing  and  C that is 35.4% of tax expenditures), as compared only  $20.8  billion  100  (representing  a  mere  2.8%  of  . 119 transfer spending)  This signifies that housing and commerce are subsidized  primarily through the tax systemtax credits, Table 6.12  exclusions and deductions  from income plus  rather than by direct outlays.  Th  of  t-hi-ii  Tax  -‘es in USA: Percentage distribution returns (1981) 36.7% 26.1%  INCOME CLASS Less than $10,000 $lO,000-20,000 $20,000-30,000 $30,000-40,000 $40,000-50,000  Real Estate Deduction (in million dollars) 3 87  of  18.4% 14.5%*  358 670 645 2,264 1,210 1,884 1,208 8,329  3.6%**  $50,000-75,000 $75,000-l00,000 $l00,000-200,000 Over $200,000 TOTAL  1990  0.6% 0.1% 100.0%  Source: Peterson (1991) p.p. 86 and 88. * returns filed by income class 30,000-50,000 ** returns filed by incomes class 50,000-100,000 The  data  in  Table  6.12  indicates  that  the  distribution  of  tax  expenditures by income class is heavily weighted towards persons and families in  the  upper  ranges  of  the  income  scale.  expenditures pertaining to deductibility of the  debate  and  discussion  leading upto  the  The  proposal  of  that year.  total  return  Persons filers)  of  the  total  Tax  Reform act  (1991)  of  1986,  was  met  The value of this HTE in  and families with incomes of over got  22.1% of  this  benefit.  The  benefit. (70.5%  paradox  of  of  $100,000  p 72.  101  (2% of  the  On the other hand,  families  the  got  return  providing  filers)  subsidy  expenditures is brought out in this quotation from Peterson  Peterson, 119  tax  which was equal to 10.7% of the total tax expenditure  and persons with incomes below 30,000 10.1%  eliminate  interest on home mortgage during  with such a large protest that the idea was dropped. 1988 was $27.7 billion,  to  through  (1991):  only tax  “The purpose of the home ownership interest deduction is to encourage home ownership by mericans, but doing this through the tax expenditure route results in large subsidies to a relatively small segment of the population. If legislation were proposed in the Congress saying, in effect, that the nation will provide quite small direct subsidies to encourage home ownership to the roughly 70 of the population with incomes below $30,000, and that these subsidies would increase rapidly as family income increases above this level, would such legislation pass? The question answers itself, yet this is the way the majority of tax expenditures work”.  6.5 Developing Countries Very  few  studies  The  expenditures.  have  studies  been  relating  done to  developing  in  the  effect  of  countries  tax  of  tax  expenditures  on  housing are even fewer. Urban housing shortages are exacerbated by rapid population growth and high  rates  of  urbanization  in  developing  countries.  Lower  gross  domestic  products of these countries preclude large-scale subsidization of housing by the governments. While the problem of housing shortage is deeply rooted in the socio-economic circumstances of developing countries, significant role in their economic development. housing  planning  effectiveness  are  critical  of housing.  It  factors  in  is paradoxical  housing itself plays a  Government housing policy and  determining  the  socio-economic  that even though governments  in  developing countries extensively use tax expenditures to steer investment in certain effect  sectors,  there  is  hardly  any  analysis  or  evaluation  of  their  120  The  Indonesian  fiscal  system was  replete with tax incentives prior to  1984121. Most of these were discontinued as evidence indicated that few if any of  the  incentives  MaktOUf and Surrey 120  Gi11iS 121  yielded  the  desired  (1990) p 204.  (1990) p 89.  102  results.  They  caused  “massive  from the treasury” and when effective had a bias towards capital  hemorrhages intensity,  as large investments received longer tax holidays.  created intractable problems tax rates  in tax administration,  on taxpayers not benefitting from them;  as  They also often  they required higher  and discriminated against  smaller firms who lack the resources and the influence to file for and receive incentives. Hong have  Kong  achieved  pursuit  of  and  Singapore  success  in  development  are  public through  among  the  housing rapid  few developing  policies  and  countries  . 122 programs  industrialization,  many  which In  the  developing  countries ignored investments in large scale public housing projects,  as the  productivity of housing investments was considered too low to be economically efficient. While most developing countries were reluctant to allocate funds to housing,  Hong Kong and Singapore began large scale low-income public housing  programs.  They  viewed  housing  as  an  integrated  part  achieved success in both housing and economic growth  of  development  and  123  Public housing programs in both Hong Kong and Singapore are considered to be essential components of the political strategies for economic and social . 124 development systems  for  responsible design, a  Both  public for  all  construction,  structured  Shen, 122 Shen 123 Shen, 124  these  countries  housing, aspects  of  have  consisting public  complex  of  housing  allocation and management.  organization,  and  each  (1986) (1986) p 38. (1986) p 39.  103  a  and  well-administered  statutory  including  body  planning,  which  is  finance,  This administrative body has  component  has  clearly  defined  responsibilities. The public housing program in Hong Kong began in 1954, destroyed homes of  December 1953 in  settlement  Kowloon.  The  Hong  Rents  lower  than  charged  for  . 125 accommodation their  huts  were  58,000 persons  these  Kong  after a fire in  in Shek Kip Mei,  government  a squatter  constructed  emergency  those paid earlier by  the  units.  low-income  Till  1972,  the  occupants  for  public  housing programs were mostly financed directly through government revenue or through low-interest loans provided by the government. These programs received government Since  subsidies public  1973,  organization-  The  and  were  housing Hong  allotted  in Hong  Kong  Kong National  financed primarily through government the authority.  After 1976,  land  at  has  less  been  than  market  . 126 value  administered by a  Housing Authority.  Its  single  activities  revenue and through rents  are  received by  land for low income housing was provided free by  the government. In Singapore,  the Singapore Improvement Trust- a government organization  in charge of building public housing,  has been in existence since 1927,  before the establishment of the Housing Development Board setting up of HOB, of  large  Singapore.  scale  in 1960.  The  a statutory body, marked the beginning of the construction  public  Capital  (HDB)  long  for  housing the  programs  construction  dominating of  public  the  housing  housing  sectors  of  was  provided  by  the  purchase  of  loans from the government to the HDB . 127 The  use  of  Central  Shen, 125  (1986)  EShen, 2 L  (1986)  8hen, 127  (1986) p 34.  Provident  Fund  p 32.  104  (CPF)  savings  for  public housing,  is central to the housing policy of the Singapore government.  The rate of contribution to the CPF as a proportion of the gross salary was increased scheme,  from  10%  members  . 128 housing  1955  could  Almost  government  in  50%  withdraw  the  securities.  to  entire  in  upto  reserve  1984.  Under  80%  of  of  CPF  the  their  CPF  total  savings  housing CPF  has  finance  savings  been  for  invested  in  A major portion has been used to provide substantial  funds to enable home buyers to meet their initial and mortgage payments,  and  to finance public housing programs. It  is  interesting  to note  that  both Hong Kong and  Singapore  achieved  success in tackling housing problems, not through tax expenditures, but mainly through  land  government. attracted  reforms, In  through public  Singapore,  through  circumstances  and  of  fiscal Hong  investment incentives  Kong  and  in  housing CPF  made  most  (unlike  Singapore  was  programs  are  savings  compulsory savings  to  finance  the  public  unique,  housing  compulsory,  countries)  employment and tightly controlled migration policies. utilized  as  .  the  and  not  However,  the  they  have  full  Both the countries have programs.  in the CPF are akin to a tax on salary,  employer and employee each deposit  financed by  In  Singapore,  whereby both the  25.3% of the salary in the  fund.  It  is  difficult to transplant similar policies with comparable success to India, due to  significant  unemployment  and the presence  of  an  informal  labour  sector.  There are also no restrictions against migration to urban areas in India. This survey of housing tax expenditures in countries other than India, shows that HTEs distinctly influence the housing situation.  The various ways  in which HTEs effect housing are discussed in the next chapter.  Goh, 128  (1988) p 155.  105  CHAPTER SEVEN  Effects of Housing tax Expenditures on Housing The effects of housing tax expenditures on housing, the  national  economy are  effects for India,  described  in  this  chapter.  housing finance and  The  relevance  of  these  is discussed at the end of each section.  7.1 Growth in Home-ownership The  national  impact  of  housing  nature of urban housing markets. rate  of  home-ownership  exception of Canada,  in  all  tax  expenditures  is  reflected  in  the  Table 7.1 depicts the post- war trend in the  selected  OECD  countries  and  India.  countries experienced a significant  With  increase  the  in the  rate of home-ownership in the early post-war years. As HTEs lower the cost of owner-occupied treatment  will  housing, enable  otherwise be the case.  it a  is  reasonable  to  argue  expansion  in  owner-occupation  greater  that  tax  favourable than  Even if the price elasticity of housing is  would  zero,  expansion can come about through tenure transfers. Table 7.1: Home Ownershio in India and Selected OECD Countries .  Countries 1INDIA 30 AUSTRALIA’ CANADA  DENMARK FINLAND FRANCE NORWAY SWEDEN UNITED KINGDOM UNITED STATES Source: Wood  (1990)  1950  1960  1970  1980  45% 65.6% N/A 55.9% 35.5% N/A N/A N/A 55%  46.27% 71% 66% 45.7% 60.8% 41.6% 52.8% 36.2% 41.8% 61.9%  47.12% 67% 60% 48.6% 60.4% 44.7% 52.6% 35.2% 49.2% 62.9%  53.61% 68% 64.3% 52% 64% 47% N/A  1986  39%(’75) 52% 65.6%  and National Institute of Urban Affairs  Refer to urban areas only, 129  and in the census years,  i.e.  Figures for Australia refer to the nearest census year. 130  106  1961,  69%(’88) 63% (‘87) 66% N/A 51%(’84) 67% 55% 64% ( ‘ 87) 63.8%(’88) (1989)  1971 and 1981.  this  It is difficult to gauge precisely the effect of HTE5, home-ownership studies  of  favourable  rates  the  in their absence  tenure  choice  cannot be  decisions  observed.  indicate  tax provisions would lead to a  that  fall of  as the trend in  However  in US  4.4k  the  in the  empirical removal  of  incidence of  . 131 owner-occupation  It is also estimated that after allowing deductions  all operating costs,  the long-term effect of taxing imputed income would be a  for  6.5 reduction in owner occupied households. In the US, tax changes. been  encouragement to the private sector has been eroded through  The remaining subsidies,  limited,  notably through tax-exempt bonds,  and they are too shallow on their own to prompt  have  investors  to  build for the group most in need, namely low-income households. The result has been a marked drop  in the production of property  moderate income groups,  for  lower-income and even  either for renting or home-ownership.  It has been estimated that between 1963  and 1979,  the number of home  owners in US was nearly 50 per cent more than it would have been without the financial  incentives  to home-ownership.  In both US  and UK the most powerful  stimulus has been the preferential tax treatment of homeowners . 132 In Britain the tax incentives to home-owners apply equally to resold and new housing and probably have more effect in raising the prices of existing housing  (by increasing demand from persons wanting to avail  tax incentives)  than in encouraging production. Developing per  capita  wood, 131  countries  income,  have  primarily  high  rates  because  owner-occupation,  owner-occupation  (1990)  Karn and Wolman, 132  of  (1992) p 121.  107  is  despite  higher  in  low  rural  areas,  and there is less urbanization . 133 In India also,  owner-occupation.  in urban areas  Home-ownership  The urban areas have lower rates of  owner-occupation  has  been  growing,  is  higher  but  there  in rural is  no  areas.  empirical  study linking this growth to the use of tax expenditures. 7.2. Urban Sprawl A feature of the growth in home-ownership has been its development on the outskirts of metropolitan areas, urban  sprawl.  Factors  change,  employment  such  and  fall  as in  and the emergence of suburbanisation and advances  energy  in  transportation have  costs  played  a  technology, role  in  the  decentralization process during 1960s and early 1970s. However HTEs are also a factor as there is evidence that they have aided the demand for larger single family units  in the suburbs of metropolitan areas . 134  fiscal problems  for the government,  expansion of  as  This has  led to other  the urban area requires  heavy public capital expenditure in infrastructure, while out-migration erodes the  economic  municipal  and  taxes  fiscal  in  the  base  central  of  the  city,  city.  central and  can  This  reinforce  the  leads  to  higher  suburbanisation  process as households move out to avoid high taxes. As labour market location constraints are less binding on higher income households, have  an  increasing  proportion  of  households  with  low  inner city areas may incomes.  These  low  incomes can preclude maintenance and improvement of the housing stock vacated  Asher, 133  (1989). As per World Development Report,  38% of total population of low income countries wood 134  (p.278).  (1986)  108  1992,  Urban population accounted for only  by high income groups . 135  Spatial concentrations of poor quality housing are  symptomatic of the problem. Indian cities have been growing, in urban sprawl,  both in numbers and area.  This growth  appears to be more due to increase in urban population , 136  rather than because of HTEs. 7.3 Distributional Impacts and Tenure choice It is widely believed that the tax system favors owner-occupied housing; because  services  the  payments  of  are treated as  owner-occupied taxable  income.  housing  on  rental  income,  owner  occupied  untaxed  Even though landlords  tax deductions not available to homeowners, tax  are  while  rental  are permitted  as long as there is some positive  home  ownership  is  said  code  in  to  be  tax-  and  home  favoured. ownership  Home  has  been  favoured  by  the  tax  UK  ownership and residential investment have been strong in recent years 7.2)  Imposition  .  substantial distortions  of  taxes  dead-weight  that  discourage  losses  given  home  the  ownership  presence  of  may  (Table  result  in  pre-existing  137  Do tax policies favouring investment in the housing finance promote home ownership  at  the  expense  of  those  preferring  or  needing  to  rent,  such  as  mobile households and the poor? There appears to be evidence suggesting this,  135  This is true in India also,  where inner city areas of cities are degenerating,  being mainly turned to commercial uses income  groups.  Developing  countries  (as warehouses or godowns)  also  show higher percentages  and are  or are being occupied by low of  owner-occupation in  urban  areas, as dwellers of the squatter colonies are not “renters”. 136  Urban population in India has grown fourfold in 40 years from 61.6 million in 1951 to  240 million in 1991. Gordon et al, 137  (1987)  109  both in the vast difference  in the cost  and direct subsidy to tenants in the US, home ownership is rising. subsidies,  of HTEs  The distributional effects of the current system of  benefits and taxation in UK show that the value of  range,  indicates  favour of homeowners  and as the figures in Table 7.2 show  is low at the bottom of the income distribution, income  in the  but  rises  sharply  taxation  that  for  policies  the  alone  tax advantages  rises slowly for most of the  highest will  income  mainly  . 138 groups  affect  the  This  housing  decisions of the richest. —-—.——  7.2  iih,1 Fvr ‘Pri,i  in UK and USA 1981*  1971*  1983*  1985*  1987*  UNITED KINGDOM  Home-ownership Public-sector rental Private rental Total rental UNITED STATES Home-ownership Public-sector rental Private rental Total rental  49.2  57.1  59.9  62.1  64.1  31.0  32.7  30.9  29.7*  28.4**  fl9.8  10.1  9.2  8.3  7.5  50.8  42.9  40.1  37.9  35.9  62.9 n/a n/a 37.1  65.3 2.4  64.7 2.6 32.7  63.5 2.7  64.0 2.5  33.8 36.5  33.5 36.0  Source: Karn and Wolman (1992) *As % of total households  32.3 34.7  35.3  p 43.  In US the federal tax expenditure in 1987 for housing amounted to $55.4 billion or 1.2% of the GNP.  In Britain estimated tax expenditures for housing  amounted to pounds 5.1 billion or 1.8% of GNP in 1982, than 2  billion  for mortgage  gains exemption.  interest  tax relief  including slightly more  and 2.8  billion for  All this goes to the owner-occupied market,  capital  whereas in US,  a  substantial amount goes to the private rental sector . 139 Both the US and the UK employ a variety of tax incentives  Hi11S 138  (1991)  icarn and Wolman, 139  (1992) p 78.  110  to stimulate  demand in the housing sector. These devices ultimately encourage supply. also encourage expansion of housing demand. deduct  interest  mortgage  income-tax  liability  by  costs the  from  amount  In both countries home-owners may  their of  They  taxable  the  income,  deduction  thus  reducing  multiplied  by  the  taxpayers’ marginal tax rate. This in effect lowers the cost of home ownership to the home-owners and increases housing demand, Britain,  since 1988,  for  deduction.  tax  investment and production.  In  loans for improvement of the property no longer qualify In  the  US  the  deduction  is  unlimited  and  applies  to  improvement loans and to vacation and second homes also. In both US and UK,  the preferential tax treatment given to home-owners  has been criticized as an ineffective mechanism for increasing production and investment in housing.  It encourages home owners to consume more housing,  as the relief applies to both existing and new housing,  but  the additional housing  consumed is not necessarily new. The ending of relief on home improvements is seen  as  existing  counter-productive,  being housing.  The  equity  and  and  leads  efficiency  of  to the  poor system  maintenance are  in  of  doubt,  because tax relief gives greatest financial assistance to those who would be most likely to be able to purchase without assistance and so does little to increase  access  to home-ownership  for marginal  buyers.  The  system leads  to  over-consumption of owner-occupied housing, which distorts the housing market, is wasteful of resources,  and may even draw investment away from other sectors  of the economy’ . 40 Tenure-neutral  tax  reforms  would  subject  owner-occupiers  and  private  landlords to the same tax provisions relevant to the investment good status of  Karn and Wolman, 140  (1992) pp 94-95.  111  housing. limit  In competitive market conditions,  allocative  distortions.  These  these changes would significantly  reforms,  within the means of lower income groups;  if  aimed  at  providing  would increase the cost of housing  for middle and higher income groups who are existing home-owners. the  housing  The larger  fraction of a country’s housing stock which is owner occupied,  the more  politically unattractive these measures become. there  India,  In  is  occupiers and landlords, tax.  wealth  Thus  the  no  discrimination  the  in  tax  treatment  of  owner-  except for exemption of owner-occupied housing from  HTEs  do  not  affect  designed to encourage owner-occupation, neutral across income classes,  tenure  choice.  Any tax  incentives  should be carefully formulated to be  as otherwise they will be regressive and will  discriminate against low and middle income groups,  thereby exacerbating their  housing problems. 7.4 Tax Incentives and Rental Property  Unfavourable tax treatment, tenancy,  account  for much of  private rental housing supply.  combined with rent control and security of  the vast  difference between US  and UK  in  the  Between 1973-1987 the private rental stock in  UK declined by more than 1.1 million units,  while in the US  it  increased by  . 41 more than 8 million units’ Mortgage  interest  on  rental  property  is  deductible  in  but  Britain,  landlords pay tax on their rental income, while owner-occupiers do not pay any tax on their imputed rent. investors,  as  depreciation  Landlords are also disadvantaged vis-à-vis on  rental  property  is  not  deductible,  other  while  on  other business assets it is. This has the effect of discouraging investment in  141  Karn and Wolman,  (1992) p 95.  112  rental units relative to other investments. Several USA.  incentives  tax  are given  to  the private  rental  sector  in  the  Mortgage interest for rental property is deductible as a business cost.  “Tax syndication”, a mechanism for producing lower-cost rental housing through co-operation between profit-making and non-profit making organizations, allows business partners to classify investment in real estate as a loss to offset tax  resulting  liabilities  from  other  income.  The  biggest  incentive  to  producers of rental housing has been the favourable treatment with regard to the  conversion The  rental  allowances  depreciation  142  of  depreciation  of  1979,  apartments  rental of  effects  in  property  tax  caused into  changes  for  were  tax  purposes.  disinvestment  condominiums again  Limitations  and  a  boom  (group-ownership  demonstrated  in  1981,  on  in  the  schemes) when  the  shortening to 15 years of the period over which real capital costs could be depreciated  increased  home-ownership.  This  the  attractiveness  resulted  in  the  of  rapid  investment expansion  housing of  relative  capital  real-estate syndicates for investment in income-producing property commercial but also residential). subsidy  to  landlords  very  flow  to  into  (primarily  The Tax Reform Act of 1986 reduced the tax  substantially  by  reducing  the  favourable  depreciation provisions, by putting an end to tax syndication; and through the taxation of  all  ordinary income  capital  gains  (including  residential)  at  the  same  rates  as  143  In India there are no HTEs designed specifically to encourage production of housing for the private rental sector,  Karn and Woman, 142 143  Karn and Wolman,  (1992) pp 97-98. (1992).  113  though the same is not discriminated  fiscally vis-â-vis the owner-occupied sector.  The constraints to the private  rental  the  provided  are  sector  regulate  the amount of  landlord  in  chiefly  rent  terminating  through  chargeable  the  rental  Rent  and also  contract,  Control  restrict  and  the  raising  laws,  rights  the  rent.  which of  the  These  provisions have led to serious problems in the supply of rental housing. Rents fixed at below economically viable levels 144 result in poor maintenance of the rental property. The perceived difficulties in getting rental premises vacated result in higher deposits being demanded. their properties  vacant  removal of rent control  rather than  In big cities, people prefer to keep  letting  them out.  It  is  estimated that  laws would bring such properties on the market,  and  aid in addressing the housing shortage . 145 7.4.2 Policies for Financing Private Rented Property Many countries have been experiencing a rise  in the relative price of  housing in both the owner-occupied and rental sectors . The increasing price 146 of housing services leads to high rent-to-income ratios, poor. and  particularly for the  The affordability issue is perceived to be an important policy problem, is  the  prime  housing markets.  motivator  of  much  of  the  intervention  in  private  rental  A common way to deal with the affordability problem has been  to enact rent controls. Although there is no evidence that controls solve the affordability problem in the private rental market of any country, evidence  This 144 Delhi,  the  that  is  existence  particularly  Bombay and  Calcutta,  evident where  of  in  rents  the  rent  inner  fixed  in  controls  city l940s  continue to be charged for prime residential property. India Today (1993). 145 146  Gyourko,  (1990).  114  leads  areas (at  of  the  to  various  metropolitan rate  of  Rs.  there  cities, 10-20  is  other  such  as  per month)  many  interventions,  increased  generate  . 147 sectors Scheme  of  which  stock  in  such example  One  involves  which  are  economically  depressed  is  wasteful,  rent-controlled  the British Government’s  potentially  in  huge  tax  order  to  private  Business  expenditures  help  rental  Expansion subsidize  to  investment in private rental stock. In addition to direct intervention via controls on rents, many countries use  direct  occupants.  indirect  and The  indirect  for  subsidies  rental  housing  subsidies usually take the  producers  form of  and/or  tax expenditures  targetted towards the suppliers of rental housing. Most of these are difficult justify  on  purely  consequence  of  societal preferences  to  economic  grounds,  but  they  often  appear  to  to alter the distribution of  be  the  resources.  they appear to benefit the supplier of rental housing more than the  However, tenants.  There are direct subsidies to both builders and renters. Most prominent direct  subsidies tend to be in the form of rent allowance schemes to poorer  renters  who  not  choose  prominent  particularly  live  to in  the  in  USA  traditional  which  has  a  public very  housing.  small  This  public  is  housing  sector. Many other countries have similar programs, and these direct subsidies tend  income  to be  countries  leading  countries.  Direct  production.  The  subsidies. to  large  subsidy  result  of  The  actual  differences for  formulae used differ widely across in  builders  direct  renter household  may  or  may  is  to  allow  subsidy  not  coverage  be  access  linked to  across to  new  reasonable  quality housing for poorer households. Direct  Gyourko, 147  subsidy  programs  are  linked  (1990).  115  with  national  budget  conditions.  Overall direct subsidy amounts appear to vary with the degree of fiscal crisis in the country,  as housing budgets are among the first to be cut when a fiscal  crisis  However  occurs.  severely.  fiscal  crises  do  not  squeeze  tax  expenditures  so  Tax expenditures are the most important form of indirect subsidy to  the private  rental  sector.  The  sector is on property owners. expenses  against  income  legal  incidence  of  tax expenditures  in this  Laws do not allow tenants to write-off housing  solely because  they are  tenants.  The  true  economic  incidence of the tax expenditures is not clear. USA private  most  has  rental  assiduously  stock owners.  accelerated depreciation made  (15  it easy to use paper  projects  that were  followed  1981  the  tax code  year economic  losses  true losers  to offset  tax  expenditure  strategy  with  revision allowed high levels lives  for  other  rental properties)  income.  of and  Consequently many  economically were turned into  large positive  net present value deals. Revision of the tax code in 1986 removed most of the tax expenditures . 148 There is evidence that investors did respond to the subsidies as large fluctuations occurred in the production of new multi-family units around the time  of  the  tax  code  changes.  However,  there  is  no  evidence  that  the  tax  expenditure programs have done anything to solve the affordability problem of poorer  increased subsidy stock  In  households.  investment  benefits  the in  being  US,  middle split  these and  programs upper  between  149  148 149  Gyourko,  (1990).  Gyourko,  (1990).  116  the  appear  income owners  to  have  led  to  rental  housing  with  and  occupants  of  some the that  In an attempt to attract capital into its small and weak private rental sector,  Expansion shares  enacted  UK  Scheme  major  a  (BES)  -  which  tax  expenditure  allows  a  tax  program write-off  through to  its  investors  in a new company that provides new private rental units.  Business who  buy  There is no  taxed capital gain if there is no sale for 5 years . 150  There is evidence that  this plan is attracting capital to the private rental  . 151 sector  There is a  possibility that the new rental units will not remain in the rental sector, as the  bidder  highest  for  these  properties  may convert  them to  owner-occupied  status. The US and British tax expenditures are not typical to other countries’ Tax expenditures are off-budget and effectively hide the real cost  programs.  of the economic distortion from the public.  The truly large tax expenditures  are targetted towards the owner-occupied sector,  and the tax expenditures for  private rental housing are dwarfed by them. In  attempts  Australia,  pertaining  to  residential  made  rental  in  1985  to  restrict  tax  expenditures  sector had to be partly reversed  in  1987.  This shows that rental income alone was not enough to make investment in this sector attractive.  However,  Badcock et al  (1991)  say that the effects of the  changes to taxation policy in 1985 and 1987 were amplified by other exogenous factors,  such as  the  housing investment,  sharp  rise  in  interest  rates,  the  cyclical  slowing of  and the resurgence of the stock market in October,  1987.  Many BES companies have announced that they will not pay dividends for 5 years. 150  At the  end of that period  (when they will not be liable for capital gains tax),  properties and then distribute the proceeds to shareholders. in private rental sector,  This indicates that the investment  is motivated by the desire to reduce tax liability,  incentives for BES companies. Gyourko, 151  they plan to sell the  (1990).  117  by using the tax  These events confirm  worked in tandem with the  both Treasury officials  and  shifts  industry  in taxation policy, lobbyists  in  their  so as  to  impression  that the restricting of negative gearing and the taxing of capital gains were principally  responsible  for  the  temporary  shortage  of  rental  accommodation  experienced in Sydney. As the government continues to use tax incentives as an instrument of housing policy, accommodation investors, In  is  dictated  expansion of supply of affordable private rental  by  the  structure  of  opportunity  India,  residential Apart  property is generally not built  useful  the  HTEs directed to encourage investment only  if  the  exclusively for  from rental housing provided by employers,  and middle-income tenants rent a portion of housing,  be  to  rather than responding directly to needs of the tenants.  private renting.  occupied.  costs  constraints  placed  by  most  low-  that is otherwise owner  in private rental sector can other  policies  such  as  rent  control laws are simultaneously addressed. 7.5 Housing Credit Institutions In  Britain,  governments  have  given  indirect support through the tax system.  building  societies  considerable  For many years investors in building  societies have had their interest taxed at a lower rate than income from other investments. As a consequence, more savings are channelled into housing credit institutions than would otherwise have occurred . 152 mortgage market,  In 1981, banks entered the  and were extended some of the tax advantages for depositors  available to building societies. In India,  preferential tax treatment of housing credit institutions  still comparatively recent  152 Karn and Wolman,  (1988)  is  and there are no empirical studies regarding  (1992) p 100.  118  their  effect.  However,  Ahluwalia  has  (1979)  elasticity of private investment exceeded two,  reported  that  the  interest  which would suggest that a tax  policy aimed at altering the rate of return could be stimulative . 153 effect  can  expected  be  from  the  tax  incentives  favouring  housing  Similar credit  institutions. 7.6 Tax Relief on Borrowing In both the US and the UK, interest payments substantial  the fact that home-owners can deduct mortgage  from their gross income for income-tax purposes provides a  public  policy  incentive  for  households  to  own rather than rent  their house. Lower income homeowners in both UK and USA receive very little benefit from tax relief. with mortgages,  This  is partly because  tax relief  applies  those owners  to  and lower-income families are less likely to have mortgages,  because they are more likely to be elderly people; and if young,  they are more  likely to have failed to qualify for a conventional mortgage both because of their incomes and the type of older property they often have to buy. income  owners  also  marginal tax rates. allowing  it  loophole  was  receive  more  tax  relief  as  they  are  subject  Higher-  to  higher  In Britain- the impact of tax relief has been narrowed by  only on  the  first  closed  by  restricting  30,000  pounds the  tax  of  any loan.  relief  only  In  1988,  to  one  another loan  per  property. In the United States there is no ceiling on the amount that may qualify for tax relief, time,  owners may claim relief on more than one property at the same  and may claim relief  Ebrill  on  real  estate  (1990) p149.  119  taxes  as  well.  As  a  result,  the  combined effect of mortgage interest and local real-estate tax deductions has been much more dramatically regressive in US than in Britain. Nearly all highincome  have been able  families  take  to  advantage of  these  savings,  whereas  only a very small proportion of low-income families was able to do so’ . 54 tax relief on borrowing for housing investment is allowed in  In India,  the form of deduction of interest. The quantum of relief is restricted and it can be  only against  set off  income  from house property.  only for borrowings from formal financial institutions, a  fraction of  provision  the total tax  for  taxable  for  non-tax  payers  also  is paid  thereby covering only bsence of  restricts  any  potential  the  It is also regressive as interest paid is deducted from  resulting  income,  relief  finance used in the housing sector.  credit  effect of the relief.  The  in  tax  larger  relief  for  persons  higher  paying  marginal tax rates. 7.7 Promotion of Home-ownership by Lower-income Groups In both Britain and US there have been periods when policies have been directed  particularly  at  moderate- income groups. 1970s,  and  Scheme,  in  Britain  originally  within the reach of below  the  basic  increasing  home-ownership  among  the  lower-  In the US this was between the late 1960s and the mid from  1979  announced  in  onwards. 1966,  was  In  designed  lower-income households,  income-tax  threshold  Britain,  and who  to  the  Option  bring  notably those whose received no  the  lenders,  of  2  per  cent  anyone opting into the scheme.  Karn and Wolman, 154  of  the  interest  on  the  Mortgage  home-ownership income was  subsidy on  mortgages. Originally the subsidy involved a government contribution, to  or  outstanding  their  directly loan  of  This was still less than the implicit rate of  (1992) p 124.  120  subsidy given to basic-rate taxpayers through MITR, so in 1970, revised to allow the subsidy to vary with the tax rate, subsidies  equivalent.  roughly  With  the  basic  tax  the scheme was  thus keeping the two  rate  of  30%,  the  option  mortgage thus required the mortgagor to pay only 70% of his mortgage interest payments,  with  the  government  institution.  The  relationship  between  purchase,  a  if  paying  the  importance of option mortgages has the  tax  threshold  and  only  to  the  lending  varied according to the  level  of  income  needed  to  tax threshold  then the take-up of option mortgages was high. The advent in  1984 of “Mortgage Interest Relief at source” pay  the  30%  large number of people with incomes below the  were able to buy,  to  remaining  the  net  (post  tax)  (MIRAS) which required mortgagors  mortgage  payment  to  mortgage-lending  institutions, placed all basic-rate taxpaying and non-tax paying homeowners on a similar footing with regard to subsidy, separate option mortgage.  eliminated the  regardless of income and in effect Until  1990,  continued to reclaim rebates over and above MIRAS,  higher-rate  tax payers  so they still  received a  larger subsidy. Other schemes to help low-income home-owners were for the sale of public sector properties,  discounted sales of council properties under the  “Right To Buy” clauses of the Housing Act 1980. In  India,  there  are  no  direct  tax expenditures  groups for promotion of home ownership. in UK would be  useful,  but  will  aimed at  income  lower  A scheme drawn on the lines of MIRAS  benefit  only  those  who  are  able  to  avail  credit from formal sources. As such credit is scarcely available to the poor, there is a potential danger in such a scheme resulting in more discrimination towards  them.  corporations, groups.  Also,  However,  tax  incentives  are  provided  to  businesses  and  for making deposits in funds used to provide housing for these private  developers  and  builders  121  have  to  provide  a  certain  percentage is  expense  the  of  housing  allowed  they  weighted  construct  deduction  lower  to  for  tax  income  purposes.  groups,  and  Similar  weighted  this  deduction is also allowed to employers  for providing housing to their lower  income  of  employees.  The  actual  incidence  such schemes  is not  known  in the  absence of any empirical study. 7.8 How Fiscal Preference Affects Different Income Groups  Hills et al(l989)  have described how fiscal incentives affect different  income groups in Britain. it  because  positively  they  is  who  associated  Support for owner-occupation reaches the better off tend  with  to  income.  reaches the worse off because of  such  subsidies  Assistance)  as  houses, In  and  general,  they tend to rent  means  the  and because  buy  rent  tested  rebates  support  the  are  benefits  for  rental  sector  (and so receive the benefits  housing  are  because  benefit  and  inversely related to  Housing  Rent  income.  This  difference in the incidence of the two types of subsidy produces an X-shaped graph,  clearly showing that the current  rich people  to  poor  are  people  become  owner-occupiers  forced  income owner-occupiers. of  the  remain  to  (though no tenants-  incentive  there  is  no  is  needed)  benefit  The current structure of subsidies stands  objective  government’s  as  strategies provide an incentive  of  extending  owner-occupation  to  for But  .  low  for  in the way people  with  below average incomes.  In comparison with the X-shape of the current system, a  tenure-neutral  would  downward effect  scheme  . 155 sloping of  HTEs  It  is  against  have  two  important  identical to  low-income  formulation of housing tax expenditures.  Hi11s, 155  Berthoud and Kemp,  (1989) p 38.  122  note  lines,  this  each  potential  owner-occupiers  when  horizontal  or  discriminatory recommending  CHAPTER EIGHT CONCLUSIONS JND RECOMMENDATIONS This  chapter  concludes  on  housing  and  policy  the  details  discussion specific  regarding  the  recommendations  effect to  of  fiscal  promote  urban  housing in India. The chapter starts with Section 8.1, wherein the limitations of the study are given.  Section 8.2 lists the major conclusions of the study.  Implications of these conclusions and recommendations for India are presented section  in  8.3.  Section  8.4  suggests  for  areas  future  research  on  this  subject. Limitations of the Study  8.1  Before presenting the conclusions fiscal policy measures  regarding  this study are reviewed.  that  of  the  study and making  influence housing,  the  limitations of  The study suffers from the constraints placed by the  limited availability of both qualitative and quantitative data. is  a  literature  vast  fiscal  policies,  finance  is  subject,  on  they  the  little  influenced by  but  surprising,  very  suggestions  individual appears  fiscal  pertain  topics  to  have  policies.  mostly  to  of  both housing  been  There  are  written some  developed  the  Though there finance  on  how  readings  countries.  and  housing on  this  This  is  as most developing countries use fiscal policy measures to attract  resources for investments in certain priority areas,  in a bid to bring about  social and economic change. One probable reason for the lack of literature in this  field  in  developing  countries  may be  that  direct  taxes  form  a  small  percentage of national revenues. As the incidence of direct taxation touches few people,  the behaviour of the majority of the population is not expected to  be influenced by fiscal policy. The effects of these fiscal policies, are also difficult  to  evaluate  in  isolation, 123  as  their  provisions  are  very  . 156 complicated 8.2 Conclusions The efficacy of tax incentives has seldom been evaluated, widespread have  there  in  use  been  developing many  and  developed  empirical  studies  . 157 countries  which  despite their  However,  suggest  that  recently  savings  and  investment are quite sensitive to tax-induced changes in the expected rate of Most of  return.  these  studies  are  focused on the United States.  Their main  conclusion is that the aggregate level of saving is not particularly sensitive to tax-induced changes in the rate of return, . 158 the composition of financial savings  although tax factors may alter  Increasing private savings may not be  the goal for tax policy in a developing country but, the  share  of  savings  those  that  flow  it may seek to increase  organized  through  financial  markets.  Although there is some evidence that investments in certain forms of financial assets  may  responsive  be  such  it  inducements,  incurred  terms  of  Among governments of developing countries,  it  benefits  are  to  distortions,  worth  the  cost  and diminished equity  in  is  not  fiscal  clear  that  losses,  these  economic  159  to operate schemes which give tax concessions.  is a widespread practice  Due to conceptual difficulties  in measurement and the inadequacy of data available, even those countries that have  made  most  contradiction  use  of  between  Buckley et al, 156  (1989)  fiscal the  developing  p 23.  Bird and Oldman, 157  (1990) p 131.  Bird and Oldman, 158  (1990), p 141.  59 and Oldman ‘ Bird  incentives  (1990) p142.  124  have  rarely  countries’  evaluated  extensive  use  them.  The  of  tax  incentives as a major instrument for achieving government objectives and the absence of any tax expenditure analysis is striking . 160 Detailed  analysis  and  evaluation  of  tax  expenditures  has  been  mainly in developed countries that prepare a tax expenditure budget, Canada,  the  UK  examination of  and  these  the  USA.  This  countries’  is  the  primary  reason  housing tax expenditures  for  in this  done  such as detailed  study.  The  shortages.  Tax  main conclusions deduced are: 1.  Most  countries intervene  in the housing market  to address  policy instruments are employed extensively to promote the housing sector. 2.  Housing tax expenditures used are generally regressive in their incidence,  as they directly impact only the tax payers,  and benefit the rich more than  the poor. 3.  Empirical  ownership,  studies show that tax incentives  encourage the growth of home-  especially in the UK and the USA.  4. Housing tax expenditures are perceived to be one of the factors responsible for  causing  urban  sprawl.  It  is  increased consumption of housing,  argued  that  such  tax  policies  encouraged  thereby causing people to move to sub-urban  areas. 5.  Housing benefits and tax incentives provided by countries  such as UK and  USA tend to favour high-income owner-occupiers and low-income tenants. This is primarily  because  tax  expenditures  for  owner-occupiers  tend  to  grow  with  income,  while benefits provided to tenants taper off with increase in income.  6.  incentives  Tax  are  useful  in directing  savings  institutions including housing finance institutions.  160  Maktouf and Surrey  (1990)  p 204.  125  towards  formal  financial  7.  Tax  reliefs  participation.  for  contractual  saving  schemes  for  housing  Similarly tax expenditures on borrowings  encourage  public  for housing finance,  encourage people to avail them. 8. Housing tax expenditures usually have only an indirect impact on low income groups. The implications of these on urban housing in India are discussed in the next section. 8.3 Policy Implications and Suggestions for India Government investment  in  governments  intervention in the housing  this  area.  intervene  to  Taxation direct  is  one  of  investment  sector the  is  essential  instruments  towards  to promote  through which  priority  sectors.  Tax  policies designed to stimulate housing can lead to an increase in the overall supply of  housing,  population.  It  measures  policy  is  thereby making seen  that  related  to  most  it  countries  housing.  section show that tax policies  accessible  to  larger  recognize  Conclusions  sections  this,  listed  and  in  of  use  the  the  fiscal  preceding  designed to promote housing may have certain  important implications,  which should be kept in mind while making any policy  suggestions  taxation  regarding  policies  formulated  to  increase  housing  finance. 8.3.1 Regressive incidence of Housing Tax Expenditures The  regressive  incidence  inherent in their structure.  of  HTE5  of  the  countries  studied  are  not  The regressiveness  is due to the way these tax  expenditures have been designed and implemented.  This problem associated with  HTE5 can be addressed through their redesign as has been done to some extent in MIRAS in UK. The real danger with tax expenditures is that, generally subject to open and thorough public scrutiny, 126  it  as they are not  is easy for such  regressiveness to creep in and go unnoticed by the public. If housing tax expenditures favourably impact the richer members of the then the crucial question is how should such policies be used for  , 61 society’  a developing country like sizable  section  of  the  India,  where per  population  lives  capita below  the  population of tax-payers in India is very limited, measures directed at them,  income  is very low and a  poverty  line.  As  the  the effect of fiscal policy  is restricted in scope and magnitude. A housing tax  expenditure system designed on the lines similar to the HTE5 used in USA or UK which explicitly favors rich owner-occupiers would not be suitable for India, as  it  would  Indonesia,  exacerbate  the  housing  where all tax allowances,  been abolished,  problems  fall  poor.  A  like  including those favouring housing,  have  as then there will be no additional  incentive for anyone to invest in housing. will  the  system  will also not suit India,  occupied housing,  of  partly on  the  Even the negative impact on ownertenants,  as  most  owner-occupiers  rent a portion of their dwelling. The current system of HTEs in India does not discriminate  between  the  owner-occupiers  and  the  regressive effects of HTE5 have also been reduced, deductions available,  tenants.  The  potential  by placing limits on the  and by providing tax credits at the basic tax rate.  8.3.2 Housing Tax Expenditures encourage Home-ownership  This effect of HTE5  is also not inherent,  HTEs have been explicitly designed to encourage  but is due to the fact that home-ownership.  reflects the political policy of the countries studied,  This is what the experience of the countries studied shows. 161 not inherent,  This  design  where home-ownership  This regressivity of HTE5 is  hut is a result of the way in which they are formulated.  However, academically it is possible to design and administer progressive HTEs for the benefit of the poorer sections of the society. The continued use of regressive HTE5, is a commentary on the political and social setup, that allow such instruments to exist, that favour the rich at the cost of the poor.  127  has  been promoted because  it  has  been  considered politically desirable  and  Similar promotion of the cause of landlords who supply  acceptable to do so.  private rental housing,  may not be accepted equally as a valid political aim  as it would be seen as promoting the interest of the landlord, not the tenant. To promote the cause of the tenant, allowance of  rent paid,  HTE5 designed in the form of deduction or  could be used.  studied use such a tax expenditure, desirable.  ownership  However,  The  fact  that none of  the countries  shows that these countries consider home-  in  some  countries,  such  as  Canada  and  UK,  direct subsidy based on the amount of rent paid is given to low-income groups. This direct subsidy is an open hand-out, in  times  permanent,  of  fiscal  crises.  It  is  which is subject to being restricted  not  but as Hulchanski and Drover  to  say  (1987)  that  tax  expenditures  are  have shown subsidies are more  susceptible to be pruned in times of fiscal restraint. In India,  taxation policies treat both owner-occupiers and landlords in  a similar manner,  and so do not encourage one at the expense of  This manner of treatment is useful, housing  built  expressly  for  the  the other.  as there is comparatively little private purpose  of  renting  only.  Private  rental  housing is generally in the form of partly let out owner-occupied housing.  If  private landlords are allowed to deduct allowances similar to business income from house property income,  However to assist the tenant,  for renting. based  on  the  the  tenants,  rent  paid  by  them.  basic  tax  rate.  However,  who do not pay any taxes,  adversely,  To  there  ensure  is need for tax allowances  that  such  tax  policies  are  they should be subject to a ceiling limit and should be allowed  progressive, at  then that would result in more housing being built  as  the  tax  paying  such  a  policy  would  not  help  the  poorer  and in the long-term may even affect them  tenants  would  128  be  ready  to  pay  higher  rents,  thereby  inflationary trends  causing  progressive  private  rental  in  housing  rents.  policy  It  is  difficult  India,  in  to promote  through  tax  a  policy  measures only. 8.3.3 Housing Tax Expenditures cause Urban Sprawl  Tax  expenditures  countries.  However,  have  in  been  India  shown  there  cause  to  is  no  urban  evidence  sprawl to  in  this  QECO  effect.  Theoretically HTEs designed to encourage housing, would lead to an increase in demand for housing,  and will cause urban sprawl.  of this potential effect,  It is essential to be aware  and take measures to address it,  as urban sprawl in  India would result in expensive and difficult to afford infrastructure costs. 8.3.4 Housing Tax Expenditures and Mobilization of Savings Lack of financial resources is a crucial constraint to housing activity individuals  for most  in India.  household level is significant. potential savings, schemes  savings  At  the same time the rate of  to  at  the  There is considerable scope for capturing the  including that of the informal sector, linked  savings  guaranteed  and  loans  through contractual  access  to  shelter.  Tax  incentives designed specifically to stimulate provision of loans by the HFI5 to  low  income  groups  would be particularly useful,  as  the  informal  sources that these groups depend on are more expensive than formal Similarly finance  tax  concessions  for  deposits  with  HFIs  that  for housing will also encourage the growth of  provide  finance finance.  long-term  finance available  for  housing. Provident deposits/bonds cash-strapped  and of  pension  housing  industry  in  funds  finance  should  be  allowed  institutions  mobilizing  resources  (HFI5). from  to  invest  This the  would  household  Considering the importance of housing finance in urban growth, 129  in  company help  the  sector.  it is necessary  that  HFIs  . 162 India  incentives  get  similar  to  those  enjoyed  by  the  Unit  Trust  Of  HFIs should also be exempted from interest tax as the borrowers of  housing loans are generally in the low and middle income groups, and this will lower their cost of borrowing. from capital option of HFIs  In addition to granting exemption to assessees  gains tax on purchase/construction of a  investing the capital gains  should also be given.  greater risk,  residential house,  in approved bonds/deposits  Since HFI5 give  they should be allowed to  long-term loans  claim deduction  the  schemes of  and are  thus at  for bad debts  from  their taxable income. Mandatory housing finance programs have been operating in countries like France,  Brazil  and  Mexico.  Such  schemes  require a proportion of salaries! wages employees,  are  established  legislatively  and  to be allocated by the employer and  contribution to the housing fund . n attractive feature of 163  for  the mandatory contribution system is a flexibility of choice of alternatives in  the  disposal  funds.  of  Similar  programs  may  be  adopted  in  India  by  introducing enforcement measures for the large/medium sized commercial firms and industrial undertakings. The  success  intermediation  of  that  a  financial  would be  prof it.  will  reflected by the  financial institution can lend. as the cost of savings,  system  be  dependent  rate  of  on  interest  the at  cost  of  which a  This cost will be determined by factors such  management expenses,  Government may provide indirect  bad debt provision and after-tax  subsidies  such as  tax advantages  to  the finance institutions for the savings received by the mobilization of idle  lnterest on deposits with UTI are subject to an additional allowance of Rs. 3000. 162 urban India, 3  (July-December, 1990)  130  funds  of  household  asset  forms.  sector,  which  Tax advantages  would  to HFI5  otherwise  be  kept  in  may only be applied to  non-financial  certain lending  programs that provide that a significant proportion of these subsidies will go to the targeted low income groups. 8.3.5 HTEs do not directly impact low-income-groups One direct  characteristic  effect  is  inherent  limited  to  in housing tax expenditures  tax-payers  only,  and  the  is  that  their  non-taxpayers,  who  generally belong to lower income groups 164 are not directly affected by them. increasing  However,  by  indirect  impacts  in  the  the  form  employment opportunities in  total of  amount  of  generation  housing of  manufacturing  for mainly unskilled and  results  in  increase  income  chances  of  securing better  of  these  housing.  groups,  Increasing  activity,  have  HTE5  activity  semi-skilled labour.  and  thereby  housing  make more housing available to them by the process of  enhances  This their  activity would “filtering”.  and  also  HTE5  can  also result in provision of more housing for the lower income groups through tax  given  incentives  to  employers  to  provide  housing  for  their  employees,  especially those in lower income brackets. It is often advocated that housing for the poor should be provided at subsidized prices, but subsidies limit the extent to which public services can contribute to increase in housing supply,  especially for the poor.  have to pay for the cost of the service according to quality,  If users  they will choose  the level of quality commensurate with their ability and willingness to pay; and  the  public  This is not always true in India, 164  as incomes of agriculturists and certain other groups  are  exempt,  large  even  agencies  though  they  will  may  have  earn  an  incentive  incomes.  exemptions rarely apply.  131  However  to  in  provide  large  services  urban  areas,  at  such  standards reflecting people’s willingness to pay. applied,  Where subsidies are widely  this incentive is generally absent at the level of the household and  the public  agency.  However,  subsidized  supply of  housing  should be  limited  only to the poorest sections and care taken to ensure that it is selectively and properly administered. initial  after  repairs,  government  Planning for low-income housing should ensure that grants  or  loans  for  housing,  a  revolving  fund  for  improvement and maintenance of housing is developed.  Some other implications of housing tax expenditures are discussed in the following sub-sections. 8.3.6 Do HTEs Divert Resources from Other Sectors? Will the use of fiscal policy instruments to attract investment to the housing economy?  finance Savings  necessarily  mean  instruments,  but  sector  result  in  the  deprivation  mobilization with the reduction rather a  of shift  formal institutional relations.  aim of  deposits  in  housing  other  from informal  of  other  areas  of  the  investment would not  financial  institutions  sector financial  relations  or to  The results of research carried out in India  show that a contractual savings scheme by which people save a certain sum of money over a period of years in return for an entitlement to a mortgage loan can increase the share of assets held by participants in financial forms . 165 Participants instruments, that  would  saving  have  simply  financial  shifted  assets  among  different  but have reallocated their savings in favour of financial assets be  available  period.  institutions  not  Thus,  for  investment  channelling  can contribute to the  Bickicioglou, 165  (1992)  .  Such  savings  of  anywhere household  in  would  also  the  during  through  the  total  the  financial  financial market  increase  saving, by reducing wasteful expenditure and conspicuous consumption.  132  economy  savings  strengthening of  schemes  the  volume  in  of  the country as a whole. 8.3.7 Rationalization of Tax Policies Fiscal income,  incentives  wealth,  gifts  provided  etc.  under  need to be  the  laws  relating  rationalized to  to  channel  taxation savings  of  into  HFIs and to promote investment in housing activity. For those not eligible for  such incentives, alternative incentive schemes, need to be designed. Provision of  concessions  in  taxes  and  duties  on  transfers,  conveyances,  leases  and  mortgages between developers or approved financial institutions and the first home-owners will be useful in encouraging the property to be registered at its actual value,  besides reducing the financial burden on buyers from the lower-  and middle-income groups.  Fiscal and municipal tax policy should be simultaneously applied by the state and local governments in order to curb speculation in vacant land and to release such land for housing and urban development. tax should go towards a shelter fund.  The proceeds of such a  A penalizing levy on vacant land would  bring most of the really excess land into use or circulation . 166 A partial  solution  for  the  housing  shortage  lies  in  recognizing  the  construction business as an industry. Lending agencies offer better terms and interest  rates  to  businesses  with  eligible for several tax concessions,  industry  status.  Industries  are  also  such as reduced rates of income tax.  A problem with the Indian housing market is that it operates partly in the underground economy.  Very few properties  for resale are advertised,  and  those that are listed do not show the price at which the property is offered for sale.  This is primarily due to the fact that a significant proportion of  D’souza 166  (1992)  133  is paid  the price  (and accepted)  Government’s attempts to counter through  acquisition  of  and  undersold  legal  delays.  given for investment in residential property, reveal the  true cost of the property, economy.  underground  In  the  that  is undeclared income.  such use and proliferation of black money,  ostensibly  by procedural  ineffective  in black money-  properties, If  more  is  fiscal  made  largely  incentives  then people may be encouraged to  thereby reducing the influence of the  present  situation,  operates significantly in the underground economy,  when  the  housing  market  fiscal incentives will not  benefit the persons who are investing their unreported income in housing. the use of black money becomes more  the  and more  costly  (through higher  it may become less prevalent in the housing sector,  incentives)  formalisation of  this  sector.  are  Reduction  of  flow  of  As  fiscal  resulting in  black money  in  the  property sector, may eventually lead to a reduction in house prices. 8.3.8 Designing of Efficient Housing Tax Expenditures There is a general consensus that an efficient tax system is one with a broad base, marginal  with simple rules  rates.  preferential consensus  increased use  social policies  on  expenditures,  The  what  to permit of  effective enforcement,  tax expenditures  to meet  and moderate the needs  of  can make it more difficult to maintain a broad  constitutes  a  fair  tax  especially housing tax expenditures,  system.  Nevertheless  tax  remain a useful tool in the  hands of governments to achieve social policies. Gillis has listed three rules for incentive-oriented tax designers’ 67 in developing countries. The first rule,  is to keep it simple.  Complex provisions  and attempts to “fine-tune” the economy are not suitable in the circumstances  167  As quoted in Bird and Oldman (1990) p131-132.  134  of developing countries. few,  Tax incentives in such countries should therefore be  and preferably  simple  be  limited  in  duration,  both  to  increase  their  impact on investment timing and to comply with the third rule stated later. is to keep good records on who gets incentives,  The second rule, and  at  estimated  what  cost  of  revenue  information, there is little chance policy.  in development  Finally,  tax  forgone.  In  the  for how long  absence  of  such  that incentives will play any useful role incentives  should always  be  subject  to  “sunset” Drovisions,  requiring them to be explicitly evaluated in quantitative  terms periodically,  and if not  best  to  keep  only simple  found worthwhile,  incentives  in  the  tax  terminated.  It  law and  charge  to  is probably the  tax  administration explicitly with the task of maintaining the required records. To quote Bird and Oldman  (1990)  “The path of wisdom for most developing countries is to avoid extensive and detailed attempts to deflect private investment into preselected channels, often with no follow-up to see what really happens and with no set procedures for ensuring that tl infants so expensively fostered grow up to be full taxpaying citizens.”  Broadening of tax base contributes to redistribution, income is largely received by high income families. the  budget  Colombia,  on  income  distribution,  countries  Studies of the impact of as  diverse  as  the  US,  Malaysia and Chile strongly indicate that if the budget is to serve  redistributive purposes effectively, the  in  because excluded  expenditure,  incentives  for  not  tax side of  investment,  Bird and Oldman 168 Gi11is, 169  the  the primary emphasis must be placed upon  by  the  definition  (1990) p 132.  (1990) p 81.  135  . 169 budget do  not  Payroll  impinge  taxes  directly  and  tax  on  the  incomes of the poorest 40 of the population in most developing countries . 170 The idea that taxes are desirable corrective devices in those cases where government  intervention  is  warranted  least since Pigou in the 1930s. that  direct  expenditure  intervention, instrument  popular  been  among  economists  at  The conflict between the tax expenditure view  programs  and the welfare  has  are  the  desirable  economist’s view that  means  taxes  of  are  government  the preferred  for government to alter the allocation of resources,  has not yet  been addressed . 171 8.4 Recommendations for Further Study This  thesis  has  reviewed  housing and housing finance.  the  ways  in  which  fiscal  policies  impact  Even though tax incentives are widely used,  the  jury is still out on the question of their efficacy. This is not surprising as the notion that tax incentives are in effect tax expenditures and thus should be  evaluated  new,  being  in  equivalence  with direct  subsidy programs,  expounded by Stanley Surrey in  expenditures  as  an  economic  is  tool  1973172.  difficult  as  While their  is  comparatively  evaluation of effect  cannot  tax be  determined in the absence of any “control situation”, their effectiveness as a social and political policy is even more difficult to analyze. are compounded in a country like India,  These problems  where public policy is formulated in  an overall interventionist framework and tax laws are complicated. There  is  expenditures  considerable  influence  5ird and Miller, 170 Bruce, 171 172  scope  investment  in  for  certain  (1990) p 427.  (1990) p 23.  Surrey,  further  (1973)  136  research  sectors.  Very  in  the  little  ways  tax  empirical  research has been done in developing countries, ways  in  which  tax  incentives,  as  such  including India, regarding the  housing  tax  expenditures  influence  investment decisions. The Indian Income Tax Act contains a large number of tax incentives,  allowances and credits to promote a variety of activities.  are frequent alterations, but  no  study  foregone, these  or  has  been  whether  concessions  deletions and additions in these tax expenditures,  done  they  are  regarding  have  either  succeeded  introduced,  in  their  cost  achieving  in their  terms  time and amount of concession. with vociferous opposition. expenditures  study is immense,  fared  in  of  taxes  purpose.  When  they are generally welcomed by the sector  they favour, but there are also demands to extend their coverage,  tax  There  in terms of  Any attempt to delete or curtail them is met  However,  there are no studies to show how these  achieving  their  objectives.  The  need  such  for  a  as only then can fiscal policies be successfully formulated  to attain what they were designed for. In view of the present and predicted shortages of urban housing,  it is  essential to explore ways to increase the amount of housing finance available. However,  the problem of  complex,  and any attempt to solve it through an instrument such as housing tax  expenditures, lO  of  the  urban housing  shortage  in  India  is  very  large  that by definition directly impacts only the tax payers urban  population),  is  likely  to  have  only  a  limited  and  (only  success.  Nevertheless tax policy is a useful instrument to address housing shortage, as it impacts persons who have the money to invest.  It would be useful to examine  tax incentives designed to encourage investment in a fund that can be used for providing housing finance to low-income residents in urban areas. could be given special tax incentives,  Such a fund  similar to the Unit Trust of India, and  the amount of finance so mobilized can be used for providing credit to persons 137  in  the  low-income  groups  for  housing.  Such  a  scheme  increase the funds available for low-income housing.  would  substantially  It would also be useful  to formulate tax incentives for mobilizing deposits towards finance of housing built through cooperative group housing schemes. One of the main constraints for housing in urban areas is the shortage of  Paradoxically  land.  vacant,  in  urban  areas  in  India,  large  tracts  land  of  lie  despite the acute shortage of land and housing. This is partly due to  the laws imposing a ceiling on urban holdings.  The land recognized as excess  under this law is generally not available for development,  due to litigation  pending in courts against acquisition of such land. Land, and housing property are  also  held  vacant  for  investment  purposes,  escalate at a rate faster than inflation.  as  land  and property prices  There is a need to devise ways in  which such vacant land and property is brought onto the market to eventually increase the supply of housing. This can be in the form of vacant land tax as is levied by Taiwan.  This will increase the opportunity cost of keeping these  properties vacant, and may result in their being offered for rent or sale. The proceeds groups.  of  the  tax  can  be used  to provide  finance  for  housing  The increase in land supply should result in a fall  low-income  in land prices,  thereby making it more affordable. Another reason for the limited supply of serviced land in big cities of India, such  land  develop land)  is the fact that only a few government agencies are allowed to develop  .  (for  and  example  supply  in  large  Delhi, tracts  only of  the  land;  Delhi  Development  private  developers  Authority are  not  can  given  This restricts the amount of land that comes onto the market and thus  increases developers  the  cost,  to  develop  exacerbating land,  the  housing  and construct 138  shortage.  housing would  Allowing increase  private  the  total  amount of housing. and  increase  developers  in  may be  Competition quality  of  required  among developers may result  housing. to  supply  To a  provide percentage  low-income of  their  in lower prices housing  these  production  for  these groups at subsidized prices. 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