@prefix vivo: . @prefix edm: . @prefix ns0: . @prefix dcterms: . @prefix dc: . @prefix skos: . vivo:departmentOrSchool "Applied Science, Faculty of"@en, "Community and Regional Planning (SCARP), School of"@en ; edm:dataProvider "DSpace"@en ; ns0:degreeCampus "UBCV"@en ; dcterms:creator "Krishan, Deepa"@en ; dcterms:issued "2009-02-25T19:23:19Z"@en, "1994"@en ; vivo:relatedDegree "Master of Science in Planning - MSc (Plan)"@en ; ns0:degreeGrantor "University of British Columbia"@en ; dcterms:description """This thesis attempts 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 India attempts to address housing shortages through subsidies, tax incentives and regulation. However, the urban housing shortage continues to increase. One of the major constraints identified is the shortage of housing finance. An estimated investment of Rs. 572 billion is required to meet the existing urban housing shortage of about 10 million units. 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 tax incentives that affect housing are commonly used in many countries. 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 policy that helps the financial institutions to mobilize household savings towards investment in urban housing is necessary. These policies can be designed to encourage the rich to invest in institutions that provide low-cost housing finance credit 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. The fiscal policy must also give incentives to employers to provide housing or housing finance to their employees. They should also encourage businesses to invest in housing for low-income groups, and developers to provide subsidized housing to them. Such incentives would also help in reducing the role of the underground economy in the housing sector. Policies that actively discourage hoarding and speculation in land and property, such as a tax on vacant land, would increase the supply of housing. In India, such fiscal policies would need to be complemented by changes in the regulatory framework to remove the deleterious effects of other policies, such as rent control laws, on the supply of housing. A tax system incorporating incentives to promote housing, 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 shortage of housing finance."""@en ; edm:aggregatedCHO "https://circle.library.ubc.ca/rest/handle/2429/5057?expand=metadata"@en ; dcterms:extent "2385223 bytes"@en ; dc:format "application/pdf"@en ; skos:note "EFFECT OF FISCAL POLICY ON HOUSING FINANCE IN INDIAbyDEEPA KRISHANB.Sc. (Hons.), University of Delhi, India, 1974M.Sc. Indian Agricultural Research Institute, New Delhi, India, 1976M.Sc. University of Bath, UK. 1989A THESIS SUBMITTED IN PARTIAL FULFILLMENT OFTHE REQUIREMENTS FOR THE DEGREE OFMASTER OF SCIENCEinTHE FACULTY OF GRADUATE STUDIESSchool of Community and Regional PlanningWe accept this thesis as conformingto the required standardTHE UNIVERSITY OF BRITISH COLUWIBIAAPRIL 1994Deepa Krishan, 1994In presenting this thesis in partial fulfilment of the requirements for an advanceddegree at the University of British Columbia, I agree that the Library shall make itfreely available for reference and study. I further agree that permission for extensivecopying of this thesis for scholarly purposes may be granted by the head of mydepartment or by his or her representatives. It is understood that copying orpublication of this thesis for financial gain shall not be allowed without my writtenpermission.(Signature)Department of ScThe University of British ColumbiaVancouver, CanadaDate__________DE-6 (2/88)ABSTRACTThis thesis attempts to identify elements needed in a fiscal policydesigned to encourage private investment towards urban housing in India. Theneed for such a policy arises due to the existing and projected urban housingshortage in India.The Government of India attempts to address housing shortages throughsubsidies, tax incentives and regulation. However, the urban housing shortagecontinues to increase. One of the major constraints identified is the shortageof housing finance. An estimated investment of Rs. 572 billion is required tomeet the existing urban housing shortage of about 10 million units. Fiscalpolicy instruments are useful in directing finance towards selected prioritysectors. This thesis suggests that the fiscal policies of India be designed toencourage private investment in the urban housing sector.Only a limited number of studies have been made to ascertain how fiscalpolicies influence housing and housing finance, even though tax incentivesthat affect housing are commonly used in many countries. These studies showthat the effect of most housing tax expenditures is regressive. The incentivesgiven by housing tax expenditures directly affect only the tax payers, andthus would be limited to the top two quintiles of Indian population. People inlower income groups would not benefit and would be discriminated against bythese policies. For increasing urban housing in India, there is need tosuggest policy measures that favourably impact all sections of the population.A fiscal policy that helps the financial institutions to mobilizehousehold savings towards investment in urban housing is necessary. Thesepolicies can be designed to encourage the rich to invest in institutions thatprovide low-cost housing finance credit to the poorer sections. This williienable the urban dwellers, including the poorer sections amongst them, to haveaccess to finance for housing at reasonable interest rates.The fiscal policy must also give incentives to employers to providehousing or housing finance to their employees. They should also encouragebusinesses to invest in housing for low-income groups, and developers toprovide subsidized housing to them. Such incentives would also help inreducing the role of the underground economy in the housing sector. Policiesthat actively discourage hoarding and speculation in land and property, suchas a tax on vacant land, would increase the supply of housing.In India, such fiscal policies would need to be complemented by changesin the regulatory framework to remove the deleterious effects of otherpolicies, such as rent control laws, on the supply of housing. A tax systemincorporating incentives to promote housing, formulated in coordination withhousing and urban planners, and with a provision for regular evaluation of itseffectiveness is likely to considerably help reduce the shortage of housingfinance.iiiTABLE OF CONTENTSABSTRACTTABLE OF CONTENTS ivLIST OF TABLES viLIST OF ABBREVIATIONS viiDEFINITION OF AN URBAN AREA IN INDIA ixACKNOWLEDGMENTS xCHAPTER ONEIntroduction 11.1 Introduction 11.2 Background 31.3 Problem Statement 41.4 Objectives of the study 71.5 Scope of the study 71.6 Methodology 81.7 Thesis Organization 8CHAPTER TWOHousing Situation in India 102.1 Housing in Developing Countries 102.2 Condition of Housing in India 112.3 National Housing Policy 14CHAPTER THREEHousing Finance in India 193.1 Housing Finance- General System 193.2 Housing Finance in India 243.3 Constraints for Housing Finance 32CHAPTER FOURFiscal Policies Relating to Housing .. .464.1 Introduction 464.2 Reasons for Government Intervention in Housing 484.3 Problems associated with Public Intervention 504.4 Definition of Tax Expenditures 524.5 How Housing Enters the Tax System 524.6 Significance of the Tax Expenditure Conceptto Housing Policy ... .594.7 Tax Expenditures and Housing Finance Markets . .. .604.8 Curtailing Tax Efficient Housing Investment . .. .614.9 Other Forms of Government Intervention ... .61:iv4.10 Comparison Between Tax Expenditures and Direct Subsidies. .62CHAPTER FIVEHousing Tax Expenditures in India5.1 Introduction5.2 Taxation Policies Relating to Housing in India....CHAPTER SIXHousing Tax Expenditures in Other Countries....6.1 OECD Countries6.2 Britain6.3 Canada6.4 United States Of America6.5 Developing CountriesCHAPTER SEVENEffects of Housing Tax Expenditures on Housing..7.1 Growth in Home-ownership7.2 Urban Sprawl7.3 Distributional Impacts and Tenure Choice....7.4 Tax incentives and Rental Property7.5 Housing Credit Institutions7.6 Tax Relief on Borrowing 1197.7 Promotion of Home Ownership by Lower Income Groups 1207.8 How Fiscal Preference Affects Different Income Groups 122CHAPTER EIGHTConclusions and Recommendations 1238.1 Limitations of the Study 1238.2 Conclusions 1248.3 Policy Implications and Suggestions for India 1278.4 Recommendations for Further Study 136BIBLIOGRAPHY 140.68.68.69.80.80.8894.99.102106106108109112118VLIST OF TABLES2.1 Projections of Housing Requirements in India 122.2 Households Living in Rental Housing in India 123.1 Housing Investment in India 243.2 Rates of Gross Domestic Saving in India 393.3 Sources of Housing Finance in India 443.4 Share of Various Sources of Housing Finance in India 445.1 Taxation in India of Housing and Other Incomes 695.2 Home Loan Account Scheme in India 716.1 Taxation of Owner-occupied and Rental Housing inIndia and Selected OECD countries 876.2 Taxation in UK of Housing and Other Incomes 896.3 Tax Subsidies to Owner-occupiers in UK 906.4 Main Forms of Financial Subsidy by Tenure in UK 926.5 Housing Subsidies, Taxation and Benefits in UK 946.6 Major Federal Expenditures for Housing in Canada, 1979 .956.7 Federal Housing Tax Expenditures in Canada, 1979 976.8 Changes in Home-ownership Rates in Canada 986.9 Changes in Renter Households in Canada 986.10 Major Activities subsidized by Tax Expenditures in USA.. .996.11 Housing Tax Expenditures for Individuals in USA 1006.12 Distribution of Housing Tax Expenditures in USA, 1990.. .1017.1 Home Ownership in India and Selected OECD countries 1067.2 Households by Tenure in UK and USA 110viLIST OF ABBREVIATIONSAssisted Home Ownership Program (Canada).Assisted Rental Program (Canada)Business Expansion Scheme (UK)Canada Mortgage and Housing CorporationCPF Central Provident Fund (Singapore)HTE..HUDCOITMIG...MIRAS.MITR..MURB..AHOPARPBES.CMHCEWS Economically Weaker SectionsFl Financial InstitutionGDP Gross Domestic ProductGIC General Insurance Corporation (India)GNP Gross National ProductHDB Housing Development Board (Singapore)HDFC Housing Development Finance Corporation (India)HFI Housing Financial InstitutionHIG High Income GroupHLA Home Loan AccountHRA Housing Rent Assistance (UK)Housing Tax ExpenditureHousing and Urban Development Corporation (India)Income TaxLIC Life Insurance Corporation (India)LIG Low Income GroupMiddle Income GroupMortgage Interest Relief at Source (UK)Mortgage Interest Tax Relief (UK)Multiple Unit Residential Building (Canada)viiNRA.NHB.NHP..NRIT.NIUA.OECD.RHOSP.Tax Reform Act (USA)United NationsUnit Trust of IndiaValue Added TaxWealth TaxNational Housing Act (Canada)National Housing Bank (India)National Housing Policy (India)Non-recurring Indirect TaxesNational Institute of Urban Affairs (India)Organization for Economic Cooperation and DevelopmentRegistered Home Ownership Saving Plan (Canada).Rupees (India) (22.50 Rupees = 1 Canadian Dollar)(31.10 Rupees = 1 US Dollar)RsTRAUNUTIVATWTviiiDEFINITION OF AN URBAN AREA IN INDIA1An urban area in India is defined as follows:(a) All places with a municipality, corporation, Cantonment board or notifiedtown area committee, etc., and(b) all other places which satisfy the following criteria:(1) a minimum population of 5,000;(2) at least 75 of male working population engaged in non-agriculturalpursuits; and(3) a density of population of at least 400 persons per sq. km. (1000 personsper sq. mile)An URBAN AGGLOMERATION is by definition the continuous urban spread consistingof a core town and its adjoining outgrowths, which may be urban in their ownrights or rural.This thesis relates to urban areas having more than 100,000 persons.1Source Shukia, 1988.ixACKNOWLEDGMENTSThe author gratefully acknowledges the assistance of the Government ofIndia, in granting leave of absence from her job and thereby providing theopportunity to conduct this study. The author also acknowledges the continuoussupport and guidance given by Dr. V. Setty Pendakur and Dr. Michael Leaf.Thanks are also expressed to her colleagues in both India and Canada whocontributed significantly to this study. Special thanks are also given to herfamily for their constant support and patience.xCHAPTER ONEINTRODUCTION1.1 IntroductionAccess to adequate and affordable housing in urban areas is a majorchallenge in many countries including India. This thesis examines the ways inwhich fiscal policy has been used to attract investment to the housing sectorin India and some other countries. It then suggests the features which afiscal policy must have to attract sufficient finance for urban housing inIndia.The tax system constitutes one of the most important instruments ofdevelopment policy in any country2. If redistribution of income is considereda desirable social goal, then taxation is an important means to that end, onethat every country utilizes, whether explicitly or otherwise. Economic growth,internal and external stability, and the attainment of an appropriatedistribution of income and wealth are some of the goals that tax policyattempts to achieve, even though they are in the realm of public policy3.Taxation is only one of the means of achieving such national objectives.Though the potential efficacy of taxes in achieving many of these purposes hasoften been exaggerated, nevertheless, as taxes are one of the most pervasiveinstruments of government policy in any economy, it is both inevitable andappropriate that the effects of taxation on such general public policyobjectives as growth, distribution, and stability need to be taken explicitlyinto account while designing the tax system.Since 1950, fiscal policies of India, have been formulated not only to(1992) p(ix)3Bird (1992) p 8.1raise revenue, but also have been used for encouraging desired social andeconomic objectives. Though this dual role of tax laws has been criticizedoften as the tax laws become more complicated and the primary objective of taxlaws to levy and collect taxes is compromised, fiscal policies have achieved asignificant measure of success in India and other countries to achieve socialand economic goals.In India, there has been rapid growth of urban population during thiscentury. The urban population increased nine-fold from 25.62 million in 1901to 240 million in l990 while the number of urban centres increased 80 percent from 1834 to 3245g. However, in spite of this large aggregate urbanpopulation, India continues to be one of the least urbanized countries of theworld, with only about 27 per cent of its population living in urban areas.The level of urbanization is expected to increase rapidly in the comingdecades, and as per estimates of The Urban Institute (1989) 41 per cent of thepopulation (projected to be approximately 460 million) will be living in urbanareas by the year 2010.As more people crowd into the cities, they will place increasinglyheavy demands on government for housing and the provision of a host ofnecessary public services, such as transport, communication, water,sanitation, electricity, etc. Even at present, there is considerable shortageof urban housing and much of the housing stock available is of poor qualityand often out of the reach of most of the urban poor. The 1991 Census of Indiaestimates housing shortage in the country to be 29.8 million units, of which4Definition of urban areas is given in Appendix 1.5me Urban Institute, (1989)29.6 million are in urban areas. The Government of India has been attempting toattract investment in housing through subsidies, benefits and tax concessions.How successful have these attempts been, in India and elsewhere, in solvingthe housing problem? Or, have these attempts become so tangled and unwieldy,that their original intent has been lost sight of? In this study, the role offiscal policies in attracting investment to the housing sector in India andother countries is examined. The effectiveness of fiscal policies inincreasing the amount of finance available for housing is examined.1.2 BackgroundIn India, a large portion of tax revenues is generated through indirecttaxes such as local excise (manufacturing) and sales tax. These taxes areregressive as they affect the poor more, who also pay them at the same rate asthe rich. As the poor tend to spend a greater percentage of their income onbasic goods, they pay a larger percentage of their income as taxes on goodsconsumed, as compared to the rich, who with their higher propensity to save,spend less and thus pay a smaller percentage of their income towards indirecttaxes. In a more equitable taxation system, the emphasis should be on raisingpublic revenues through progressive taxes, such as urban property taxes,income taxes and wealth taxes. The incidence of these taxes rarely falls onthe urban poor as the basic exemption limits above which income and wealth aretaxed, are fixed at a high level. Although the taxes designed to stimulateindividual investment in the housing sector may directly affect only thebetter-off urban dwellers, such investment also has a spillover effect inimproving the housing situation of the urban poor by raising their incomethrough generation of employment. Tax policies designed to stimulateinvestments in low-cost housing, whether by the employer, or the state, or the3private sector indirectly benefit the urban poor.The manner in which public revenues are spent is also of greatsignificance in improving the equity and efficiency of the urban system. For amore equitable urban growth, urban investment, pricing and regulation policiesneed to be designed to assist those forms of housing, sanitation, transportand other related services that meet the needs of a majority of the urbanpopulation including the poor, and at costs they can afford.1.3 Problem StatementThe post second world war era has seen significant increases in percapita income, life expectancy and literacy rates in most parts, of the world.This is particularly evident in the developing countries when contrasted withthe earlier era of almost stagnant growth. The rapid economic developmentduring the latter half of this century accompanied by political changes thatled to a large number of countries gaining independence from their erstwhilecolonial masters, has led to a tendency for greater involvement of the Statein the welfare of its citizens. In India, which gained independence in 1947,government has not only directly invested in certain priority sectors, but hasalso used fiscal policies to try to attract private investment into theseareas. Thus fiscal policy aim not only to raise revenue, but, for example, bygiving tax breaks, encourage investment in specific industrial sectors orgeographical areas.Housing, conceived as a set of services, is an important aspect of theenvironment that has a profound impact on the socio-economic, physical andpsychological development of human-beings. Yet a sizable fraction of theworld’s population does not have adequate shelter and lives in extremelyinsanitary and unhygienic conditions. Housing is a global problem, to which4even the developed countries have not been able to find an acceptablesolution. The problem is more acute in developing countries, where a sizablepopulation lives below the poverty line, and the low per capita incomeprecludes larger provision of housing and shelter by the government.The urban housing situation in India is cause for grave concernespecially in view of trends predicting rapid urbanization. One of the majorconstraints identified for urban development is the lack of adequate financefor urban shelter6. Since 73 per cent of the population is rural and theeconomy is still predominantly agrarian, it is not surprising that thegovernment has been more concerned about rural development, and hasconcentrated its resources and policies in that direction7. However, theimportance of urban development has also been acknowledged in recognition ofthe fact that urban areas are the engines of development and the growing roleof manufacturing and service sector in the economy. The twin constraints oflow per capita income and large urban population make it imperative that theutility of scarce resources is maximized. For that, it is essential thatcomprehensive policies for mobilization and optimum utilization of both publicand private finances are formulated and implemented. Due to inadequateinvestment in housing, the backlog of housing shortage has continued to growin India. In 1991, it was estimated that a financial outlay of Rs. 571.8billion8 was required to address the housing shortage of an estimated 106The Planning Commission, (1992).For example, in 1991-92, Rs. 3571 millions were spent on rural development, against Rs.41.8 millions spent on urban development. In addition, Rs. 876.9 millions were spent on housing(both urban and rural). (Source: Government of India, (1993) pp 4-5).8Planning Commission, (1992).5million units in urban areas.An efficient housing finance system based on the principle ofcompetitiveness, should be able to raise the bulk of its resource requirementsby mobilization of household savings in competition with other participants inthe market. It is difficult for the housing sector in India, as in most othercountries, to rely solely on the market determined system. Thus, governmentintervention becomes necessary to ensure that adequate resources are mobilizedto meet housing needs.Several tax incentives and concessions have been given to individualsand companies for housing, but they are of a peripheral nature and their realvalue has fallen due to inflation. Also, as the threshold above which incomesand property values are subject to taxation are fixed at a high level9, andmany activities and sections of the population are exempt from income tax,less than one percent of the total population pays income tax. Therefore, itmay be expected that, any direct tax policies will only affect the housinginvestment decisions of people who pay tax and that these measures will nothave 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 rentinghousing units they also provide a large proportion of housing for theiremployees. If the fiscal policies are designed to encourage investment inhousing for rental purposes or for employees, they would go a long way inaddressing the problem of housing shortage. Such policies can also be designedto attract investments in a government fund that is used for giving housing9lndividual incomes above Rs.35,000 are subject to income tax, as compared to average percapita income of Rs. 10,000. Also as various incomes are exempt, only 8 million persons areassessed to income tax out of a total population of 840 million - that is, less than 1 percent.Sloans to the lower income groups. Housing activity encouraged by fiscal policymeasures would also have significant spillover effects, especially in terms ofemployment generation, and would thus benefit the non-taxpayers indirectly.The problem of urban housing shortage in India is very large andcomplex, and as direct taxes apply only to less than one per cent of thepopulation, the impact of fiscal policy measures designed to increaseinvestment in housing is likely to be limited. In such conditions, thesemeasures are likely to have only a moderate potential in addressing the issueof shortage of housing finance.1.4 Objectives of the studyThe objective of the study is to determine the influence of fiscalpolicies and instruments on housing finance, by studying the situation inIndia and some other countries, and to attempt the formulation of a model forIndia that shows how fiscal policy instruments can be used to increase housingfinance.This is a theoretical and exploratory study, attempting to examine howthe fiscal policies influence the amount of finance invested in housing.Fiscal policy measures that will increase the amount invested towards housingare suggested. The study may lead to the formulation of a hypothesis thatthrough fiscal policies the amount of finance invested in housing can beinfluenced.1.5 Scope of the studyThis thesis is restricted to the study of influence of fiscal policymeasures on availability of finance for urban housing. Only the direct taxpolicies of the federal or central government, that are related to the housingsector are studied.71.6 MethodologyCan investment in urban housing be influenced through fiscal measures?n attempt is made to answer this question by examining the fiscal policies ofsome countries, such as Canada, USA and UK, to the extent that they affecturban housing. These countries have been chosen, as they have made significantimprovement in urban housing.This study utilizes secondary information. Qualitative and quantitativedata from publications in the UBC library has been collected and studied so asto gain an understanding of the theoretical principles underlying theinfluence of fiscal policies on housing finance, and also to study the fiscalpolicies of various countries and analyze their effect on housing finance.Additional material was obtained through publications of the Government ofIndia to study the situation in India10. On the basis of these, a modelincorporating the fiscal policy measures that could result in boosting theamount of finance invested in housing finance in India has been formulated.1.7 Thesis OrganizationThis thesis consists of eight chapters. Chapter one introduces anddefines the problem selected to be studied and details the methodology of thestudy. Chapter two describes the housing situation in India. Chapter threegives a descriptive analysis of the system of housing finance with specialreference to India. In Chapter four, the concept of government interventionfor encouraging investment in desired sectors is examined. Special attentionis given to the theory regarding the use of tax expenditures in the housing10The student has also drawn on personal experience gained as a bank officer in India, anofficer in the taxation department of finance ministry of government of India, a student offiscal studies, and as a resident of metropolitan cities of India.8sector. Chapter five details the housing tax expenditures in India, whilethose in certain other countries are described in Chapter six. In Chapterseven, the effects of housing tax expenditures are analyzed. Chapter eightconcludes the study and gives policy recommendations regarding housing taxexpenditures in India.9CHAPTER TWOHOUSING SITUATION IN INDIAThis chapter starts with a discussion of the housing situation indeveloping countries. The next section discusses the housing situation inIndia. Highlights of the policies proposed in the National Housing Policydocument of India are discussed in Section 2.3.2.1 Housing in Developing countriesHousing shortages are a problem in almost every country, and theprovision of adequate housing presents a challenge for government policymaking. However, the severity of urban housing shortage varies from place toplace and it is generally observed that it is most severe in the big cities ofdeveloping countries.The urbanization process in most developing countries represents asocio-economic reality, characterized by the mismatch between population andresources, enormous disparity in the distribution of income and wealth, andthe concentration of population in cities. In most of the developingcountries, the rate of urban population growth is high while the progress ofeconomy is relatively slow. This leads to differences in the labour supply andlabour demand which in turn results in underemployment and unemployment.The disparity in the distribution of income and wealth is the underlyingreason for the universal existence of the housing problem. Low levels ofincome in developing countries, and the disparity in distribution of incomeand wealth result in a much higher proportion of the population living in“absolute poverty”11. Under these circumstances, it is difficult for the11Linn, (1983) p4.10developing countries to find sufficient resources to satisfy various needs ofthe population, including housing.The housing problem in the cities of developing countries is deeplyrooted in socio-economic circumstances. Therefore, the solution requires thatthe combined effect of mis-match between the population and mobilizedresources, and the disparity in the social and the spatial pattern ofdistribution, be addressed and reduced. This needs to be done to such anextent that even the poorest urban households can earn enough to satisfy theirbasic needs including housing.2.2 Condition of Housing in IndiaThe condition of a country’s housing stock is a highly visible indicatorof the quality of life enjoyed by its citizens. The majority of Indianpopulation cannot afford even basic housing from their own financialresources, without external assistance by way of loans/grants, either from thepublic sector or from private sources. Public sector institutions in the areaof housing, mostly depend on allocations from government budgets. Competitionfrom other priority sectors such as agriculture, industry and defence,prevents sufficient allocations for housing in the national budget.Consequently a large part of the urban population is not adequately housed12,and it is estimated that 9.55 million units would be required to meet theurban housing shortage projected for the Eighth Five-Year Plan period (1992-1997)13. Table 2.1 gives the break-up of the housing requirements projectedduring this period.2Sivashanmugam, (1987)‘3me Economic Times, New Delhi. (11th February, 1994) p. 17.11Table 2.l-Pro:jections of Housing Requirements in India (1992-1997)Number of Housing Units Required (in millions)Rural Metro Other urban Total Urban TotalUpgradation 4.07- 1.75 1.75 5.82New stock:EWS 6.45 1.18 2.17 3.35 9.80LIG 1.34 1.04 1.90 2.94 4.28MIG 0.25 0.31 0.58 0.89 1.14HIG 0.10 0.22 0.40 0.62 0.72Total new stock 8.15 2.75 5.05 7.80 15.95neededTotal housing 12.2 2.75 6.80 9.55 21.77requirementSource: The Economic Times; New Delni. (11th February 1994).Notes: EWS- Economically Weaker SectionsLIG- Low Income GroupMIG- Middle Income GroupHIG- High Income GroupRental housing in India is predominantly an urban phenomenon, as thepercentage of households living in rental housing in urban areas far exceedsthat in rural areas. During the period 1961-1981, the percentage of urbanhouseholds living in rented houses has shown a decline.Table 2.2: Households living in rental housing in India1961 1971 1981*Rural 6.39* 6.24* 6.97*Urban 53.73% 52.88* 46.39*Total 14.80* 15.43% 16.48%Source: National Institute of Urban Affairs, (1989a); p.*Does not include data for the states of Assam, Gujarat, Jammu and Kashmir andNagaland; and the Union Territory of Delhi.The advantages to the tenant of rental housing are zero investment;greater flexibility and mobility. However, all the money spent on rentalhousing is a consumption expense, whereas expenditure on ownership housing isalso an investment. Ownership of housing in all societies including India,enjoys a superior status. In India, the expected high rate of inflation ofhouse prices, uncertainty relating to future levels of rent and to frequency12of movement, the prevalence of practices such as “pugree” or key money14 makeownership housing even more attractive.It is estimated that to house everybody, 3 million units are needed tobe produced every year, against the annual production of about 310,000 unitsduring the eighties15. The sheer magnitude of the housing problem makes itnecessary to have a phased program to eradicate this shortage. In 1987- TheInternational Year of Shelter for The Homeless- the Government of Indiaresolved to provide a dwelling to each household in the country by the year2000. In this endeavour, the thrust in the housing sector was proposed to comeprimarily from the private sector. The role of the public sector was to be alimited one, concentrating primarily on providing subsidized housing to thepoor, including the economically weaker sections (EWS), slum dwellers, anddock and plantation workers. The public sector would also provide financialsupport to housing boards, development authorities to undertake landacquisition, and development and housing construction, primarily for low- andmiddle-income groups. The private sector would have to play the major role inaugmenting the housing stock.National income accounts indicate that housing investment as a proportionof gross capital formation in the country has declined from about 30 percentin 1950 to only about 12 percent in 197516. Housing contributed 16.72 per cent14This is the deposit tenants pay the landlord when renting premises. The amount may varyfrom 3 months rent to 3 years’ rent.15The Urban Institute, (1989)16Mohan, (1982) p1. This is primarily due to the diversification of the economy, with largeinvestments in the industrial sector.13to gross domestic capital formation in 1984-85 and 3.22 per cent to GNP17. Thegrowth of gross capital stock in housing in terms of real value has only beenabout 1.5-1.6 per cent per year, compared to the annual population growth ofover 2 per cent. Census data indicate that the quality of shelter per capitahas declined over the last 30 years, as measured by indices of crowding. Forexample, between 1961 and 1971, the average number of persons per roomincreased from about 2.6 to 2.818. Pbout 51.2 million people live in slums andsquatter settlements and about 50 per cent of urban households live in crowdedone-room tenements. There has been a 30-50 per cent rise in the propertyprices in every major city of the country in the last two years19. The trendof urban property appreciating faster than other investments is likely tocontinue, as while the overall population is growing at the rate of 2.1 perannum, the population growth of urban areas is over 4 annually20.2.3 National Housing PolicyThe Government of India adopted its National Housing Policy (NHP) in199221, wherein it recognized that housing forms an important part of thestrategy of the government for the alleviation of poverty and employmentgeneration, and is viewed as an integral part of overall improvement ofeconomic development. The rapid growth of urban population and itsconcentration in 300 cities with a population exceeding 100,000 has led to17urban India, (July-December 1990) p 101.18Mohan (1982) p1.19lndia Today, (August 1993); p. 114.20Sivasankaram, (1991)2Government of India (1992a)14congestion and overcrowding in small houses, steady growth of slums andinformal settlements and severe pressure on civic services. This has beenaggravated 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, reductionof homelessness, and provision of a larger supply of developed land andfinance to different income groups. For supply and management of land, thecentral and state government would, among other things, use fiscal andmunicipal taxation policy, including tax on vacant urban land, in order tocurb speculative activities, and to increase the supply of serviced land. Forconservation of housing stock and rental housing, the M{P envisages steps tobe taken by the central and state governments and financial institutions, forproviding fiscal and property tax incentives and financial assistance forexpansion and upgradation of dwelling units and for proper maintenance ofbuildings.The NHP recognizes that the bulk of the housing in the country isconstructed by the people themselves with their own resources. The crucialrole of government at different levels is not to seek to build houses itself,but to make appropriate investments and create conditions where all may gainand secure adequate housing, and to remove impediments to housing activity. Itis envisaged that 20 per cent of the requirement of investment in housingwould be met by specialized housing finance institutions (HFIs), insurance andbanking sector, provident fund, mutual funds etc. and through additionalmobilization of household savings. The objective of the NHP is to promote easyaccess to finance for different housing activities and to evolve an elasticand widespread resource mobilization strategy to tap household savings in the15formal and informal sector. Steps would also be taken for the removal ofconstraints to the flow of finance into the housing sector.In the interest of long-term development of the mortgage market and toprovide assured resources for the housing finance system, increasingproportion of the resources of public financial institutions will bechannelled into housing with lending rates reflecting the average yields ofthese resources. Apart from diverting increasing proportion of annualprovident fund accumulations for housing finance, housing-linked savingsschemes for the workers in the organized sectors and public sector employeeswill be introduced.It is envisaged that, The National Housing Bank (NHB-the apex agencycharged with linking the housing finance system with the financial sector as awhole) will facilitate the promotion and regulation of HFIs in the public andprivate sector, refinance their operations, and expand the spread of housingfinance to different income groups all over the country. The Housing and UrbanDevelopment Corporation (HUOCO) will be strengthened and its resourcesincreased for meeting requirements of providing shelter for lower incomegroups in rural and urban areas, and for expanding infrastructure facilitiesin the urban areas. The complementary roles of different agencies andinstitutions in public and private sector concerned with land development,house construction and finance will be supported.Innovative savings and lending institutions in public and private sectorwill be introduced to integrate the housing finance system with the capitalmarket by enabling HFIs access to the funds on a competitive basis with otherfinancial institutions and by permitting NHB and HUOCO to set up mutual fundsfor housing, apart from their access to external aid. Steps will be taken to16introduce a secondary mortgage system in order to attract funds from a widerange of investors, including insurance and provident funds, and to integratehousing finance with the overall financial system. The long-term goal of TheNational Housing Policy is that the housing finance system as a whole becomesself-financing. It should be able to meet the needs of different income groupsand purposes, with longer repayment periods, graduated payments and simplifiedprocedures; so as to ensure affordable installments and larger coverage acrossdifferent urban and rural areas.The need to carefully target capital and interest subsidies for urbanand rural poor; and to make improvements in the housing finance procedures andshelter delivery system in order to bring down the cost of shelter for thepoor to affordable levels; is recognized in the NHP. The housing financesystem will be devised to respond on flexible terms to a variety of shelterneeds of the rural and urban poor.The need to make a detailed assessment of the role of informal creditnetwork and community based savings systems for housing, and to devise ways ofestablishing its links with the formal credit institutions, so as to enhanceaccess of the urban and rural poor to housing finance, is acknowledged. Thecooperative housing movement, especially for the lower and middle incomegroups, will be given assured access to institutional finance to supplementinternal resources.The NHP proposes to provide fiscal incentives to promote investment inhousing activity by the private sector and individuals, and to channeladditional savings for housing activity from households and enterprises. Toinduce employers in the organized sector to provide housing for their workers,tax incentives will be given for investment in rental or ownership housing,17especially for low income employees. Similar incentives will be given topromote the building of new building materials and components produced out ofindustrial and agricultural wastes, and those which substitute the use ofscarce resources like wood, and energy intensive materials like cement andsteel. The levy of stamp duty and registration fees will be rationalized,especially to reduce the financial burden for lower income groups. Governmentwill encourage housing schemes in the major cities to channel foreigninvestments in residential property, and would extend appropriate incentiveslike speedy clearance by Central, State and Local governments to stimulate asustained and large in-flow of such investment.Investment in rental housing, especially for the lower and middle incomegroups will be stimulated by encouraging individuals and groups to constructhouses for full or partial letting by providing access to land, institutionalfinance, enabling regulations and incentives in central, state and municipaltaxation of property and incomes.The chief constraints in provision of adequate housing for all urbandwellers are shortage of land, and shortage of finance. Though land is fixedin supply, more land can be developed if finance is available. So, to addressthe question of housing shortage, it is essential to examine the issue ofhousing finance. This issue is examined in the next chapter.18CHAPTER THREEHOUSING FINANCE IN INDIAIn this chapter, the basic features of housing finance are examinedfirst. Section 3.2 describes the housing finance system in India. This isfollowed by a discussion of the constraints to housing finance in India insection 3.3.3.1 Housing Finance - General systemThe basic proposition of the housing finance process is that a loan isrequired by most people to purchase a house 22 This is primarily because,buying a house is probably the largest single expenditure incurred by mosthouseholds, and also because people buy houses when they are relatively young,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 housepurchase are provided directly by the holders of financial assets, without theintermediation of a financial institution. As the financial requirements ofborrower and lender can never be identical, the direct system can never befully efficient.2. In the contract system, potential house purchasers commit themselves to aperiod of saving, after which they are eligible to a loan. This systemencourages thrift, and enables people to acquire loans at relatively cheaprates. This system is used extensively in three OECD countries: France,Austria and West Germany.3. The deposit taking system is the most common system. Institutions, such as22Boleat, (1986), pp 83-98.19commercial banks, savings banks, cooperative and mutual banks, that in thecourse of their business raise deposits from the public, use these deposits tomake housing loans. In a number of countries there are specialist deposittaking institutions; e.g. building societies in Great Britain, Australia, andNew Zealand, and savings association and federal savings banks in the USA.4. The mortgage bank system has the attraction of matching long term housingloans with long term bond issues. Generally, rates of interest on both loansand bonds are fixed. The institutions operating the mortgage bank system donot need a branch network, and thus their overhead expenses are much lowerthan deposit taking institutions. This system is used extensively in theContinental European countries, especially Italy, Sweden and Denmark. Themortgage bank system worked well when interest rates were relatively stable,but it has proved more problematic when interest rates have been variable23.Variable interest rates cause unseen fluctuations in the monthly mortgage tobe paid, but they are much fairer between consumers. If interest rates risepeople would prefer to continue with low interest rate loans, but wheninterest rates fall people do not want to be committed to long term loans athigh fixed rates. It is difficult for consumers to forecast the future trendof interest rates, and time their purchases accordingly. With a fixed rate ofinterest there may be people living alongside, paying significantly differentmortgage rates. Fixed rates of interest are damaging to housing markets, aspeople may defer or prepone their decision to buy in accordance with theirexpectation of interest rates, thus amplifying the normal cyclicalfluctuations in the housing market. Variable rates are also beneficial to23 Boleat, (1986)20HFIs.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. It is unattractive for institutions, other thandeposit taking institutions, to service and hold house purchase loans becauseit is fairly labour-intensive and requires a branch network, if economies ofscale are to be captured.2. By direct loans to HFI5.3. The institutional investors purchase marketable unsecured securities issuedby HFI5. These give liquidity to the institutional investor while providingthe lender a steady source of funds for house purchase.4. Secondary mortgage market, which is huge in USA, enables the HFI thatoriginates and services a mortgage asset, to sell it to another institutionwho holds the mortgage in its loan portfolio.The relationship between housing finance and the broader macroeconomicsituation of a country has been extensively debated. Burns and Grebler(1977)24 conclude that new housing investment as a proportion of grossnational product at first increases with the wealth of the country, and thendecreases after a point. Buckley and Madhusudan (1984)25 find that there is asignificant positive correlation between financial deepening and the level ofhousing investment across their sample of more than 30 countries. Malpezzi(1990)26 also stresses the critical role of housing finance in the developmentquoted in Hoffman et al, (1991); p. 33.25Hoffman et al, (1991) p 34.p34.21strategy. By treating housing more as a consumption good than as aninvestment, planners fail to recognize its potential for encouraging savingsand enhancing other sectors of the economy.House prices are strongly influenced by the components of the cost ofcapital, such as the marginal tax rate of the market clearing buyer, propertytax rate, before-tax nominal discount rate, mortgage interest rate, and theexpected rate of house price appreciation. Increases in financing rate andproperty tax rates and reductions in marginal tax rates and expectedappreciation all lead to reductions in house prices. These elasticities risewith the income tax bracket of the homeowner. The value of housing- relateddeductions and exclusions rises with the income tax bracket of the homeowner,which holding other factors constant, lowers the cost of capital27.Boleat (1986) has reported a significant positive correlation between acountry’s level of development and its use of financial intermediation. Healso stresses the importance of informal housing finance and savings, thesource of more than 80 per cent of housing investment in developing countries.Provision of housing finance is an important element of housing policiespursued by the governments of developed and developing countries of the worldin the post world-war era28. Investment in housing is viewed as a necessarycomponent of the package of investments for promoting socio-economicdevelopment, as it does not merely create a shelter, but also provides otherbenefits. Increasing emphasis on more investment in housing is a direct offshoot of the welfare state goals of the modern governments.27Lea and Johnson, (1984), p 260.28Wood (1986)22Housing in both developed and developing countries is under-invested.The financial markets in housing in developed countries are comparativelybetter developed than in developing countries, where they are still in theirinfancy. Investment in modern housing stock and housing services in thedeveloping countries is inadequate due to low per capita income, high landprices and rising construction costs on one hand, and due to inadequatefinancial assistance from their underdeveloped financial systems on the other.In developing countries, access to housing finance has traditionallybeen limited to persons with higher incomes. The reasons for this may includeprohibitive income and down payment requirements for housing to meet loanunderwriting standards, a perception by lenders that lending to lower incomehouseholds is difficult and risky, or the fact that lending institutions withlimited funds lend only to the least risky borrowers. Struyk and Turner(1986)29 argue that expanding the population of borrowers is an integral partof improving the living standards in the developing world. Quasi-formal andinformal credit programs are vital in providing credit to the poorest andleast privileged citizens of developing countries, who are excluded from theformal-sector lending process. Struyk and Turner (1986)30 have reported thataccess to formal housing finance leads to improved housing quality andinfrastructure services in Philippines and Korea.A central theme of much of the more recent housing finance researchconcerns “Enabling Strategies”31.Enabling requires that national governments,29A8 quoted in Hoffman (1990) p 51.30Ibid, p 54.31 Hoffman, (1991) p55.23rather than provide housing or subsidies directly, facilitate the provision ofhousing by liberalizing the market, building up support systems for housing,and integrating housing markets with broader capital markets and macroeconomic policy.3.2 Housing Finance in IndiaTABLE 3.1: Housing Investment in IndiaTotal investment in the Investment in housing ofPlan Economy (Billion Rs.) (Billion Rs.) housingPeriod investment tototalinvestment ineconomyPublic private total public privat total —e1st- 15.6 18.00 33.60 2.5 9.0 11.5 341951-562nd- 36.5 31.00 67.50 3.00 10.00 13.00 101956-613rd- 61.00 43.00 104.0 4.25 11.25 15.5 151961-664th- 136.55 69.8 226.4 6.25 21.75 28.00 121969-745th- 314.0 161.61 475.6 10.44 36.36 46.80 101974- 796th- 975.0 747.10 1722.1 14.91 115.0 129.9 7.51980- 857th- 1681.5 1800.00 3491.48 24.58 290.0 314.5 91985- 908th- 77.50 697.46 774.961992-97(proposed)Source: Urban India: (July- Dec. 1990). p .25.Note: In general all plans are for five years. However, there were 3 annualplans from 1966-1969, and 2 annual plans in 1990 and 1991.There has been a steady increase in the quantum of housing investment inIndia, since 1950 (Table 3.1) . However, in percentage terms, the share ofhousing investment to the total investment in the economy has been declining,from 34 per cent in the first Five-Year plan (1951-56) to 7.5 per cent in the24sixth plan period (1980-85). While the private sector investment in housinghas declined from 50% in 1950 to 16% in 1990, the share for public sectorinvestment has gone down from 16% to 1.4%. This decline is due to reduction inthe share of investment in housing relative to investment in other sectors.The Indian housing finance sector has two distinct sectors- formal andinformal. The formal sector includes specialized housing finance institutionslike the Housing and Urban Development Corporation (HUDCO), HousingDevelopment and Finance Corporation (HDFC), the cooperative housing financesocieties and the state housing boards/development authorities, and alsogeneral investment institutions like the Life Insurance Corporation (LIC), theGeneral Insurance Corporation (GIC), the Unit Trust of India (UTI) and thecommercial banks. The primary function of the general financial institutionsis to protect the interests of their main beneficiaries, whose savings theycommand, and housing finance is a supplementary effort, triggered by theirsearch for alternative investment opportunities. They also invest in housingto fulfill national commitments to social-oriented sectors32.The informal housing finance market is quite unique to the developingcountries. In India, it is also the more important component. It includes theindigenous money lenders and bankers, friends, relatives and employers, whosupplement the personal resource mobilization efforts of the individual homeowner- who may also utilize his cash savings in addition to what he can raisethrough liquidation of self-acquired or inherited assets.Over three-fourths of the annual financial investment in the housingsector in India is from the informal sector, while only 22.6 per cent comes32La11, (1985>25from the formal financing institutions. The central and state governmentsprovide a substantial proportion of the finance through budgetary allocations.The contribution of specialized financial institutions has been graduallyincreasing, with the spread of activities of HTJDCO, HDFC and the cooperativesocieties. There has also been some increase in the investment flows throughthe provident fund organizations, but the relative contributions in terms oftotal financing have not improved in the case of the commercial banks, GIC andLIC to any noticeable extent. The overall role of specialized financialinstitutions is not substantial enough to make a discernible impact on therole of the informal housing finance market33.The housing finance market has relatively little interaction with thenational capital market. This is due to several factors, such as the non—availability of a mass level institutional framework to mobilize savings atcompetitive rates of interest, the need of housing sector for long-term creditwhereas the capital market may supply mainly short-term funds, the non-availability of attractive salable financial assets from the housing sectorand the general disinclination of commercial banks to finance housing activityas a normal business operation. Another important characteristic of the formalhousing finance market is the dependence of specialized institutions on thepublic sector, either the central or state government and LIC and GIC. Theseinstitutions have had little success in tapping household savings.In the informal housing finance market, the most important supplier offinance is the extended family of the home owner. The home owner mobilizes hisown resources from his savings, as well as liquidation of assets. Relatives33La11, (1985)26and friends also provide substantial support. The indigenous bankers and moneylenders play a very crucial role in the case of people in low income groups,residents of smaller cities and persons with casual or seasonal incomes. Inthe informal housing sector (including slums and squatter settlements), therole of indigenous money lenders is significant.Housing finance for the middle- and high-income-groups is providedmostly by the private sector and also by HTJDCO and HDFC at the national level,and by housing boards and development authorities at the state level. Thesegroups also have access to finance provided by their employers, commercialbanks and insurance companies. In larger cities, the members of these incomegroups have been forming group housing cooperative societies, whichcollectively bargain for allotment of serviced land and finance. The bulk offinance is generally obtained from the HFIs and allocated to individual housebuilders. There is combined preparation of plans for the layout and houses.Benefits of economies of scale are availed in the purchase of buildingmaterials. Even after completion of construction, the society is notdissolved, but takes over the functions of repair and maintenance of thehousing stock and public areas of the colony. These cooperative group housingsocieties have been very successful in the metropolitan towns and areencouraged by the Government as they bring about augmentation of housing stockin a planned and legal manner. In India there were 60,000 housing cooperativesby 1991, with over 4 million members34. The Cooperative Housing Movement hasto its credit over 1 million constructed houses. The cooperative sector hasinvested Rs. 40 billion in the housing sector and every year Rs. 6 billion34Government of India, (1992)1127more are added. About 60 per cent of housing finance disbursed by apexcooperatives has gone to economically weaker sections and lower income groups.As part of the land allotment policy, government gives preference tocooperatives in the allotment of land.Even for the middle- and high-income groups, a significant portion ofhousing finance comes through informal channels. Apart from personal savingsand borrowings from family, friends and relatives, an indigenous system ofraising large amounts of interest free loans has been developed. This is thechit fund system35. The operation of chit funds is not confined only to thepurpose of raising finance for shelter. The chit fund system of raisingfinances, is used extensively, but not exclusively, 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 housingfinance, even among the better-off people, who have access to formal avenuesof finance, illustrates two points. First, the formal financial system isstill undeveloped and rudimentary, so even the more affluent sections of thesociety have to resort to informal methods. This deficiency of the financesector perpetuates the extralegal sector- which in turn results in a large35A number of persons- friends, relatives, colleagues and even neighbours pool the sameamount of money. The total amount so collected is given to a member of the group, whose name ispicked up by draw of lots. This procedure is repeated every month, for as many months as thereare members, and each month another member is allotted the total amount in the fund- which isknown as chit fund, after the chits on which each member’s name is written. In this manner themembers of a fund have access to interest free loans. They are also able to save a target sumwithout going to a bank or institution, where apart from feeling intimidated by the proceduresand forms, they will also be required to produce collateral or security and will have to sign anumber of statements and pledges. The chit fund system operates in an informal manner and alltransactions are verbal and without any tedious book-keeping. The system operates on the basis oftrust and friendship where an occasional default is covered up by friends. More persistentdefaults are addressed through peer pressure- from relatives, friends and seniors in workplaceand neighbourhood. A chit fund may operate with installments of any amount.28parallel economy. The second point illustrated is that, the volume ofinvestment required for shelter is so large that all avenues of finance areexplored and exhausted and a large portion of future earnings is alsocommitted. The relative quantum of investment required for a three-room housein a middle class locality of Delhi is worked out at a total of a person’saverage salary for eight years36. Considering that an average household hasonly one salary-earner and can save upto a maximum of 25 per cent, it meansthat all the savings of the household for 32 years (almost the entire workingtenure) are required to provide for a house of its own. This large outlay fora house leaves little for other major expenses, such as illness or educationand marriage of the children. It stands to reason that when the better-offfind it so difficult to have housing of their own, the situation for thepoorer sections, who can afford to spend only about 5-10 percent of theirearnings towards provision of housing is even more grim.The very high cost of housing units and the difficulty in obtainingadequate financing for expanding the supply of low-priced housing placesadditional burden on low-income-groups. The poor are generally excluded fromconventional financing schemes due to high interest rates and restrictive loanterms. Moreover, the efforts of the government to provide housing for low-income-groups have rarely reached the targeted population. Instead, thebenefits of conventional solutions are absorbed by the upper- and middleincome groups because of high housing and infrastructure standards that thepoor cannot afford.A sizable proportion of the urban poor in India are employed in the36Pugh, (1990)29informal sector. This informal sector provides cheap labour and products forthe formal sector, for whose promotion and expansion most of the governmentpolicies are geared. As the informal sector is kept impoverished in thedevelopmental system, conventional construction and housing financialinstitutions are unable to address the needs of this sector. Thereforealternative non-conventional strategies are needed to help supply the housingrequirements of this segment. Explicit policies and mechanisms are required tobe created for the lower-income groups employed in the informal sector, as thepolicies for the rest of the population cannot meet their different needs.These policies have to recognize the strengths and abilities of thepoorer sections whom they are meant to benefit. Generally it is assumed thatthe poor are so poor that they are unable to save anything. But it is reportedby UN (1978) that despite very low incomes, they can achieve an unexpectedlyhigh rate of saving when a strongly desired item is seen to be accessible andcan be purchased in small and easy installments. This observation is supportedby Sivashanmugam (1987) who has reported that in the lowest income group(earning Rs. 700 or less p.m.), 43 per cent of the households save regularly;while in the next income group (earning Rs. 701-1500 p.m.), 85 percent of thehouseholds save regularly.To encourage savings among the poor for housing, it has been suggested37that there should be deposit insurance and indexation of savings for housingof the poor from inflation. Preferential tax rates for such savings have beentried successfully in Korea and Indonesia. The involvement of commercialbanks, trust funds and insurance companies not currently engaged in direct37united Nations, (1978)30lending for mortgages is likely to increase competition among the housingfinance institutions and could lead to better terms for their clients. Thepoor show exceptional ability to mobilize indigenous resources. They salvagewaste, old and non-conventional building materials from demolition sites andgarbage dumps. They are able to construct dwellings at costs much lower thanany system of public sector construction, yet their investments aresubstantial both in aggregate as well as for each household. A survey of Poonaslums38 indicates that the best shanty dwellings (constructed by the poor) arecomparable to, or are better than any public sector provided EWS housing, andcost just over Rs. 2000 on average in contrast to Rs. 8000-10,000 cost that isthe minimum rate that the public sector can provide at.1n important role is played by HUDCO for meeting the housing needs ofthe poor. It has financed over 2.6 million dwelling units in the urban areassince 1960, and of these 90 per cent have gone to poorer and vulnerablegroups.For meeting the needs of housing finance in India, the National HousingBank (NHB) was established in 1988. It is providing assistance through anumber of schemes, such as, Home Loan Account Scheme, liberalized lending bycommercial banks and refinance facilities. Refinance for land development andshelter programs of public/private agencies and cooperatives in order toincrease 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 variouscommercial banks and other housing finance institutions and cooperatives. Overhalf-a-million accounts have been opened under the Home Loan Account scheme,(1982)31mobilizing household savings to the tune of almost one billion rupees (Govt.of India, 1992)Apart from the creation of the NHB, the banking sector in India has beeninvolved substantially in housing finance. Revised interest rates have beenfixed for the housing loans advanced by the commercial banks and housingfinance institutions.Another source of formal housing finance is housing loans fromemployers. These are provided by all the public sector employers; and by largeprivate sector firms. However, the incidence of this type of formal finance isquite low, as it is restricted only to the small section of the populationthat is employed in the formal sector- thereby excluding not only the personsemployed in the informal sector and by small private firms, but also the self-employed and the unemployed. Even the persons who are eligible for these loanshave to wait a considerable period before they are eligible for the loan andalso due to the limited amount of funds available for such loans. It would beuseful to examine policies that would encourage more firms to give housingloans to their employees.3.3 Constraints for Housing FinanceBy developing country standards, the Indian financial system is bothsophisticated and large relative to the GDP. Furthermore, the rate of savingis high, averaging 22 per cent in the l980s. The depth and breadth of theIndian financial system exceeds that of most developing countries, even thosethat are more developed than India39. But, the Indian financial system is alsomonolithic, Only a few financial institutions have access to most of the39Buckley et al, (1989) p19.32country’s financial resources, and most of these are government controlled.These institutions are highly regulated and tend not to compete with eachother. They act as instruments of government investment policy as theyallocate resources according to government directives, rather than in responseto market incentives.The key constraint in housing investment has been the lack of anorganized system of housing finance on a large scale as only a few agenciesprovide finance for housing. Only employees in the organized sector haveaccess to such finance, not the self-employed and others outside the organizedsector. Considering that persons not employed in the formal sector form asizable portion of the urban population, it is imperative that a widespreadsystem of housing finance is established. The aim should be to provideinstitutions at the local level where an individual can go to obtain mortgagefinancing at reasonable rates for a long term. To fulfill this aim despite theproblem of availability of long term finance, Mohan (1982) has suggested thatthere should be simultaneous formation of Apex Housing RefinancingInstitutions, Mortgage Insurance system and local level housing financeinstitutions. The local level housing finance inst—i-tutions such as housingbanks are required to mobilize savings for housing by offering attractiveschemes, and then ploughing these savings back into the community in the formof housing loans and mortgages. The Apex Housing Refinancing Institutions areneeded to refinance the mortgages for which the funds can be raised from longterm sources of finance, such as LIC, GIC, provident fund etc. There is needto provide mortgage insurance systems to make the mortgages safe andmarketable. There has been some progress in India in establishing local levelhousing finance institutions through the formation of National Housing Bank,33but without the other two institutions it has a limited impact on the overallhousing finance situation in the country.The small amount of housing investments made by formal FIs can beexplained by the fact that very few assets are involved. The more developed aneconomy is, the greater is the extent of financial intermediation. In the caseof housing investment in developing countries, relatively large numbers ofsmall loans are involved, raising transaction costs. Severe problems arise ifshort-term deposits are transformed into long-term loans. Recurring highinflation makes lending for housing production unattractive, and there oftenexists a lack of confidence in young FIs. These factors explain the very lowinstitutional participation in housing investment in India. The contributionof the commercial banks amounts to hardly 10% of the institutional housinginvestment, i.e. less than 1% of the total market.Apart from addressing resource constraint, contemporary policies mightalso have to be adopted to improve the scope for an increase in housingproduction. Guarantee of tenure, would not only stimulate low-income familiesto improve their dwellings but would also increase their chances of obtainingaccess to the existing financial and mortgage systems40. The formation ofvoluntary associations and building societies, in which the participant lowincome families could unite, with the aim of increasing their credibility withexisting financial systems and a transfer of land rights, would also bebeneficial. A further relaxation of building codes and a more efficient supplyof building materials (cement, steel and timber) would deflate housing costs.40Such loans are cheaper than loans raised through the informal sector, mainly indigenousbankers who charge usurious rates of interest. Also, their savings would earn interest, unlikecash savings.34A better environmental infrastructure (roads, drainage, levelling and waterand sewage connections); and further development and application of low-costbuilding technology for housing construction; would go a long way instimulating housing construction.Housing finance and land policy are the two major areas in need of theattention of policy makers in the economics of housing reform41. Reforms andprogress in housing finance can lead to increased supplies of housing, withpossibilities of extending housing wealth and welfare to moderate and low-income groups. However, housing finance can also lead to housing and landprice inflation. One key consequence of this is that low-income access tohousing is impeded, and housing resources are diverted to the upper and richerend of the housing market.Housing systems in developing countries are inequitable, reflecting theprior inequality in the ownership of capital and earnings from work in theproduction-consumption economy. Competition for housing and good street spaceis intense because supply falls short of demand. This results in insanitaryslums or living on the pavements. From the reformist perspective the housingpolicy has three clear purposes in such a context42. First, the incomegenerating potential for the total economy, especially in the informal sector,has key significance. Second, it becomes a priority to increase the supply ofhousing across a wide range of distribution of income. If supplies to thehigher percentile ranges are not increased, then some housing provisions forlow-income households will be bought from them by the more affluent. Third,41Pugh, (1990)42Pugh, (1990)35specific policies to improve the housing welfare of low-income households areneeded.Urban development creates assets which in total represent enormouseconomic and social value. There is potential to add to urban investment, andto use housing policy as a means of extending property rights in assets. Thefurther down the profile of income distribution that asset value in land andhousing is extended, the more will policy be redistributional in favour ofmoderate and low-income households.To spread the extent of owner-occupied housing and land, housing andland policies have to be coordinated to ensure that land price escalation iscurbed. If ineffective land policies, speculation in land, and restrictedavailability of housing capital occur, resources in housing will mainlyconcentrate with upper income groups. In these circumstances supplies of newhousing and land will be trickled out at low levels. Strong competitionfavouring the wealthy will push up land and building costs. Housing marketsoperate efficiently when there are high rates of employment, low rates ofinflation, low interest rates, and competition among builders and43financiersHousing production has its economic costs but it also has economicbenefits that spread into the general economy. It adds to income andemployment, it upgrades skills, it reduces social costs such as the value oftime lost from sickness, it motivates savings and it contributes to thegeneral economic and social development of the society. It is estimated thatan investment of Rupees ten millions in housing would yield employment for 670Pugh, (1990)3644man yearsOn the demand side of the housing market, such things as the willingnessto pay and the choice of priorities among food, housing, and other things arereadily expressed. But in many crucial parts of markets and production, supplyis not adequately forthcoming. In India, the bottlenecks to supply include,insufficiency of building materials, blocked access to land, inadequatemortgage and credit markets, and continuously low additions to the housingstock. Land price inflation is also evident and problematic. Further problemsarise, because rents are controlled and government regulations on pricesinfluence many building materials. Rent controls and regulations lead to thedevelopment of black markets and black economy. Rent controls undermine thelong term supply of private rental housing. The rate of development in publicrental housing does not fulfill the demand and need for rental housing.Savings towards housing investment can be induced with tax incentivesand the development of housing credit institutions. By enlarging housingcredit, the potential demand is brought within affordable loan and mortgageinstruments, leading to expanded production and competition among housingfirms. Housing markets and housing sector become better organized.In the context of low income housing, the question of affordibility inthe provision of adequate housing becomes a key issue for both the private andpublic sectors. In the past, as a rule of thumb affordibility was taken at 20%of the income; either for rent or for repaying installments on loans45.Affordability varies greatly, especially with regard to the amount of saving44urban India, (July-December 1990) p102.pugh, (1990> p77.37in the household and in how their housing expenditure varies when their incomeincreases.As housing is a basic need, economists would expect low degrees ofresponsiveness when income increases. Malpezzi (1985)46 has reported thatevidence from developing countries shows that housing has low incomeelasticity of demand. However, housing does absorb some share of increase inincome over the medium and longer terms, providing there is some perception ofimprovement in housing conditions. If a household can have access toaffordable loans, it can upgrade its housing standard and pay for thecontinuation of these standards over the duration of the loan and beyond.With useful and effective initiatives in public policy, some savingsand investments can be used to enlarge the volume of resources that go intohousing. Housing finance is the key link in the potential for transforming thehousing and social urban investments into property and benefits for themasses. This is not inevitable as it would not materialize if flows of savingcoming from the general community are channelled into higher-income housing.The process to assist a wider range of income groups, depends upon the termsand conditions built into the design of housing credit.Typically formal HFIs provide less than 20% of the annual investment inhousing. Most of that investment is channelled to higher income groups andupper ranges of middle income groups. As an economy modernizes, its capitalmarkets grow and become more specialized, with some development in housingfinance. But, housing and non-housing capital have distinctly different needsand economic forces. Generally, housing requires longer term finance than46As Quoted in Pugh (1990) p. 77.38industry. It also functions best when placed on a revolving basis so thatflows of borrowing and lending are continuous, providing the capacity to grow.The efficiency of saving institutions is important, because it keeps the costof borrowing down. But in a developing country the costs of reachinghouseholds and tapping their saving potential can be considerable. It may benecessary to establish a network of localized branches and to deploy outreachprograms in order to induce the savings habit. Innovative and flexible savingsschemes are required among low-income households, so as to adapt to theirregular and intermittent nature of their income.3.2 “ v” ‘ Tri,H-.- ---Public Private, Household Total*Plan period sector* corporate sector*and cooperativesectors *1950-51 1.8 0.9 7.5 10.2First Plan 1951-56 1.7 1.0 7.7 10.4Second Plan 1956-61 2.1 1.3 9.0 12.4Third Plan 1961-66 3.4 1.8 9.1 14.3Annual Plans 1966-69 2.4 1.3 11.0 14.7Fourth Plan 1969-74 2.9 1.7 12.8 17.4Fifth Plan 1974-79 4.7 1.6 15.6 21.9Sixth Plan 1980-85 4.0 1.8 16.7 22.5Seventh Plan 1985-90 4.5 2.2 17.0 23.7(target at 1984-85prices)Source: Sivashanmugam (1987) p 74.* As a percentage of GDP at current valuesAs Table 3.2 depicts, there is a great savings potential in the generalcommunity. Households as a whole are net savers in the economy. Thedevelopment of capital markets can be hastened by using housing as a means andas a motivator.39Mulkhraj in l98O’ reported that when home ownership and mortgageobligations were taken up by moderate-income families; there were changes inthe patterns of income and consumption. Income tended to increase, mainly fromsupplementary or overtime work. In the first years of repayment, consumptionis pressed down, but it becomes more efficient and productive. Waste isavoided, expenditure on children’s education, clothing of women and childrenincreases; as the family feels a status and situational change.The development of housing credit has a number of dimensions and someproblems to overcome. The FIs will be exposed to competition in the capitalmarket, where they lend for the long term but borrow within the confines ofintensely competitive short-term conditions. The realities of competition,changes in the rates of interest, and the general performance in the nationaleconomic management, with its impacts on inflation and employment, can affectthe flow of funds. The institutions have operating risks, such as, borrower’sdefaults, collapse of market in a recession, and intensive competition for thedeployment of savings. Risks can be moderated, borrowers can be constrained topay higher proportion of their own savings in deposits for home purchase,higher standards of collateral can be imposed, and income eligibilities can bemade more restrictive. All these reduce access to moderate and low incomegroups. It is these very conditions, along with limited flow of funds, whichcreate a situation where formal housing credit serves only the borrowing needsof the higher income groups in the developing countries. This can become aproblem for all income groups because housing credit expansion that is tied tothe upper end of the housing market can inflate housing and land prices forPugh, (1990)40all groups. Competitive pressures drive up prices and steer resources to theupper end of the market.Developers often find that capital is not always readily available tofinance the building and marketing process. In developing countries this oftenmeans that projects will be commissioned only when the ultimate consumers, thehousehold, have made their arrangements to obtain credit and to so organizethis, that it finances the building process. In this way private developerscan finance their production and reduce the risk of failing to sell theirproduct. But, the process is restrictive and cumbersome. Housing would flowmore rapidly if developers learnt how to interpret market preferences and leadthe market. It would mean that they took more of the risk, and would bepossible if finance were available from the capital market to resource thedevelopment and construction of housing. It should be possible to serve awider range of opportunities in the housing market, including sites andservices schemes, which need not be provided by the government only but can beprivately organized or be planned and executed under joint venture schemes.Housing credit and mortgages connect the supply of housing to the demandof households. Accessibility to credit and installment purchase becomes allimportant. This accessibility depends upon the duration of the loan, the levelof rate of interest, and the amount of deposit that is required as a downpayment. Banks and building societies48 establish their loans on the basis oftheir supply of funds, the income level of applicants, and the secured valueof the property or a collateral asset value in the borrower’s standing in48The building society movement is non-existent or undeveloped in most of the developingcountries. The building society movement began in Britain. In the earlier years of the industrialrevolution, some skilled workers created small scale savings funds so that members could borrowin times of need. From these funds came some housing allocations for home ownership.41owning wealth. In the developing countries, the banking sector often has somemutual savings funds and there are money lenders who charge high rates ofinterest.Formal sector housing finance serves mainly the high- and middle-incomegroups. Loans are available from cooperative societies and a few specializedHFIs. Typically the loan meets only about 47 per cent of the price of thedwelling. The price of a typical dwelling is about 8 times the value of annualhousehold income of the borrower. The average income among borrowers is aboutRs 33,000 per annum, and this compares with low-income families who have about8,400 at the top of their range, and about Rs 4,000 near the bottom49. Suchfinance is not affordable to the masses, and even for the more affluent itdoes not flow in significant volumes to meet all the demands.Existing HFIs overlook the household sector that contributes about 74per cent of total domestic savings50. These formal agencies depend on eitherbudget allocations or borrowings from other financial institutions (LIC, GIC,UTI and commercial banks) which in turn mobilize the household savings,resulting in multifinancial transfers in the housing finance intermediation.This results in increased cost of finance to the ultimate beneficiaries;irregular supply of funds to the housing agencies and over dependence on otherfinancial agencies. The savings instruments used by the HFIs are notcompatible with household characteristics. Sivashanmugam has put forward thehypothesis that creation of appropriate institutions and instruments willbring the household savings into housing finance intermediation.pugh, (1990)50sivashanmugam, (1987)42As per the National Building Organization51 the total backlog of housingis 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. Morethan 80 per cent of housing finance comes from private savings and non formalsources of credit. Housing finance institutions would be required to mobilizehousehold savings through operations of innovative saving programs includingthose linked to credit for housing and the capital market in order to raisehigh volume resources through a combination of cost effective debt and equityinstruments.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 ofborrowers it assists is small52. Existing lending procedures are too rigid toallow small borrowers to take advantage of the liberal terms and conditions atwhich the formal institutional sources extend housing finance. Loan to housingcost ratios are extremely low, and these result in poor quality ofconstruction.Public investments in housing are extremely low in India, accounting foronly l.5 of total development assistance. Public, institutional sectorprovides only 20-25 of the total housing investments, while the rest isprovided by the household sector- household and other non-institutionalsources53. The informal sources of finance, which are mostly used by the poorare generally more expensive. There exists a dualistic housing finance market,51As quoted in The Planning Commission (1992).52National Institute of Urban Affairs, (1992) p (ii)53Ibid, p (xi)43wherein there is a very high degree of dependence by the poor and low incomehouseholds on own savings and informal, non-institutional sources, and on ownsavings and formal and institutional sources by relatively high and middleincome group of households.Table 3.3: Sources of Housing Finance in India% of households Magnitude of investment by sourceSource of finance (million Rs.)Savings only 14.8 Savings 10.25Formal credit & 24.2 a. Savings 22.09Savings b. Formal credit 25.06Informal credit & 40.5 a. Savings 14.61Savings b. Informal credit 6.13Formal credit, 20.5 a. Savings 25.64Informal credit & b. Formal credit 18.93Savings c. Informal credit 9.40ALL 100.0 a. Savings 72.58 (54.9%)b. Formal 44.00 (33.3%)c. Informal 15.53 (11.8%)d. TOTAL 132.11 (100.0%)Source : National Institute of Urban Affairs (1992) p 9.Table 3.4: Share of Various Sources of Housing Finance in IndiaPercentage shareSource of financeFORMAL SOURCES 33.3a. Provident fund and employer 10.9b. Banks and others 10.3c. Specialized HF agencies 12.1INFORMAL SOURCES 66.7a. Savings 54.9i. Cash savings 33.8ii. liquidation of assets 21.1b. Loans from friends & relatives 9.9c. Loans from indigenous bankers 1.9TOTAL INVESTMENT IN HOUSING FINANCE 100.0Source: National Institute of Urban Affairs (1992) p 11.Tables 3.3 and 3.4 give the details of various sources of housingfinance as reported in a survey conducted by the National Institute of UrbanAffairs(1992) in certain cities of India. This survey shows that the sampledhouseholds generally used more than one source of finance for housing. Formal44sources of finance were used more by households belonging to upper incomegroups. However, they also used informal sources.Housing finance is one of the key determinants of housing. Given thehuge shortfall of both urban and rural housing in India, it is imperative toincrease the available amount of housing finance. As formal housing financeconstitutes only about one-third of the total, and that also benefits a smallfraction of higher- and middle-income sections of the population, the poorersections are left to finance their housing needs through informal finance,which is more expensive. In the next chapter the issue of how fiscal policiescan increase the amount of formal housing finance, is examined.45CHAPTER FOURFISCAL POLICIES RELATING TO HOUSINGThis chapter contains a discussion of fiscal policies relating tohousing. The introduction in section 4.1 details as to how governments usetaxation and fiscal policy measures to achieve public policy objectives.Section 4.2 examines the reasons as to why governments intervene in housing,while section 4.3 gives the problems associated with such intervention.Section 4.4 defines the term “tax expenditures”. The ways in which housingenters the tax system are discussed in section 4.5. The significance of thetax expenditure concept to housing is described in section 4.6, while taxexpenditures and housing finance are discussed in section 4.7. Ways to curtailtax efficient housing investment are mentioned in section 4.8. Other forms ofgovernment intervention are listed in section 4.9. The last section, section4.10 compares tax expenditures with direct subsidies.4.1 IntroductionThe relation between taxation and economic growth has long been a matterof concern to policy makers and students of public policy54. The classicaleconomist analyzed the effects of taxation on growth and the related questionof distribution of incomes, while in Keynesian economics, the effects oftaxation on the stability of economics became an important subject ofanalysis. Subsequently, the effects of taxation, on the distribution and therate of growth of national income, on employment and on other policyobjectives, were also studied. Gillis et a155, list the objectives of fiscal54Bird and Oldman, (19O) p 1.Quoted in Bird and Oldman, 1990.46policy as the promotion of economic growth, the reduction of incomedisparities between households and regions, the promotion of economicstability and economic efficiency, and the increasing of returns from naturalresource endowments. In a mixed economy that is pursuing planned economicdevelopment, such as India, fiscal policy plays a central and multidimensional role. To quote the Seventh Five Year Plan (1985-90) document ofIndia,“Through it (fiscal policy) the government creates and sustains thepublic economy consisting of the provision of public services and publicinvestment; at the same time it is an instrument for reallocation of resourcesaccording to national priorities, redistribution, promotion of private savingsand investments, and the maintenance of stability5The principal way in which fiscal policy influences growth is throughthe efficacy, or otherwise of mobilizing resources for development. Fiscalpolicy also affects growth by influencing the efficiency of resourceallocation, both within the public economy and without. In India, fiscal57policy has been used extensively for giving special inducements for savingsThe current phase of economic development in India has led to a largeincrease in its urban population; and consequently a huge housing shortage. Toprovide affordable and adequate shelter for all, the availability of adequatefinance and an efficient delivery system is essential. n efficient housingfinance system based on the principle of competitiveness should be able toraise the bulk of its resource requirements by mobilization of householdsavings in competition with other participants in the market. It is difficult56Acharya, (1988) p. 287.87Acharya, (1988) p 290.47for the housing sector, at its present stage of development to rely solely onthe market determined system where resources are likely to be driven tosectors that offer the highest return. Thus, there is need for the governmentto intervene to ensure that adequate resources are mobilized to meet housingneeds. Taxation policies are one form of such interventions through whichgovernment attempts to attract resources to the housing sector.Taxation policies form an important part of fiscal policies of acountry. The term “fiscal policy” applies to the use of public financeinstruments to influence the working of the economic system to maximizeeconomic welfare58. Fiscal policy makers concentrate on specific objectives,such as reduction of the rate of inflation, acceleration of the rate ofgrowth, and redistribution of income. The instruments of fiscal policy areboth revenue and expenditure. Among the revenue instruments the most importantrole is played by taxes; however governments also rely on fees, on the pricesof public utilities and on sales of assets. In addition to providing revenue,each tax can also be used to achieve particular goals.In many countries there appears to be a propensity to introduce taxincentives in response to almost any new or promising investment idea. Helpfor a backward region, stimulus to a new/existing industry, provision ofdesired services like housing for the poor and not-so-poor; all of these havebeen and are the objectives of investment tax incentives in many countries59.4.2 Reasons for Government Intervention in HousingWhile there is a divergence of opinion as to whether housing should be58Taflzj (1990)59Boskin and Mcclure (1988)48treated as a free market or as a social need, it is widely accepted that eventhough the market can be used to allocate much of the housing stock, there areparticular problems that require public intervention for the reasons6° listedbelow: -1) Housing policies favouring the poor can be used as a means ofredistribution of income towards the poor, who would otherwise suffer from badhousing condition as a consequence of poverty. Housing is considered to be a“merit good” whose consumption is politically acceptable to promote. Poorhousing exacerbates other personal problems and can yield to growth of socialevils.2) Governments intervene to attain vertical equity through redistribution ofincome; and to attain horizontal equity, by tax benefits that aim towardstenure neutrality.3) Government interventions ensure that the true effect of externalities, andspillover effects of improving one’s house on the neighbourhood are accountedfor.4) High cost and long life of housing means it requires long term finance,against uncertain future income. By public intervention, it is possible toencourage investments in housing in keeping with its true value to thesociety.5) Intervention may be done to promote interests of a particular group.Mobility of labour can be promoted by giving access to subsidized housing tojob movers. Rent control, subsidy policy, and policies to provide stability tomortgage interest rates; can be and have been used to counter inflation.60 Hills, (1991)496) Intervention for wider political or social aims may be resorted to. Thismay be to promote a social mix of people in neighbourhoods and to preventformation of ghettos. This can be in the form of provision of subsidy or taxconcessions to certain groups who are to be moved to a particular region.Interventionary policies that encourage owner-occupiers may be used in aneffort to create a “property-owning democracy”61,based on the assumption thatproperty owners are more conservative and less inclined towards revolution.7) The market mechanism is unlikely, on its own, to produce an efficientallocation of property. As the ownership of land and housing property isgenerally unevenly distributed, so the market is not likely to allocate theincome from these in the way the community would wish.For these reasons all governments intervene in urban land and housingmarkets, although to widely differing degrees. Intervention takes many forms,including a regulatory framework, taxation, subsidies to particularactivities, and direct ownership and participation in urban investment and theprovision of services.4.3 Problems Associated with Public InterventionSeveral practical issues have proved problematic when designing suitablemeans of intervention. These affect the choice of techniques and thedistributional consequences of such intervention.1. Multiple objectives: Many interventionary techniques are introduced withthe hope of meeting often incompatible, multiple objectives. Theoretically,any tax should not distort the working of the market, except positively tomodify allocation in line with defined objectives; it should be equitable,61Hills (1991) p 21.50treating those in similar circumstances similarly, but capable of being usedto redistribute from rich to poor; and it should be a good revenue source,easy to collect and difficult to evade. The problems of devising a tax thatmeets these requirements in principle alone are very great; even withoutconsidering the practical difficulties of implementation62.2. Undesirable side effects: Many policies operate in unpredictable ways. Evenif the government has been able to specify objectives and design policiesconsistent with their achievement, unwanted side effects may significantlyreduce their value.3. Technical problems of definition and operation: These arise because it isextremely difficult to turn theoretically straightforward interventionaryapproaches into operational policy instruments.4. Perversion of instruments to meet other ends: A tax incentive may be usedby interest groups to promote a particular activity, which may no longer beuseful in the government’s perspective. If the interest group is verypowerful, then it would be politically difficult to alter the provision.Advantage may also be taken of the intervention to create tax shelters; andthus evade taxes.5. Legal and administrative problems: In an attempt to fine-tune theintervention, the legal provisions are generally made complex. It may beadministratively difficult to determine the eligibility for concessions. Alsoeach intervention is discriminatory against some people not benefitted andthey may challenge the policy legally.(1991)514.4 Definition of Tax ExpendituresA tax expenditure is usually defined as a departure from the generallyaccepted tax structure that produces a favourable treatment of particulartypes of activities or groups of taxpayers. Tax expenditures can take the formof: 1) tax exemptions, where income from particular sources is excluded fromthe tax base; 2) tax allowances, where sums are deducted from assessableincome in order to arrive at the taxable income; 3) tax credits, amounts arededucted directly from tax liabilities, and may or may not be allowed toexceed tax liabilities; and 4) rate reliefs, where specific activities ortaxpayers are subject to reduced rates of tax. The term tax expenditureemphasizes the proposition that, in principle, all tax expenditures can bestructured as a direct expenditure program and thus evaluated in directexpenditure terms.Though the notion of tax expenditure appears to be an oxymoron, there isa basic logic to the concept63. The way in which people and business aretreated for tax purposes gives the government enormous power over the amountof money income that people finally get and keep. Tax expenditures are basedon the fact that the tax system is not neutral, people in like circumstancesare not treated equally in the way they are taxed. They concern the extent towhich the tax system is used as a deliberate instrument to change thedistribution of money income that would prevail if taxes were truly neutral.Tax expenditures are more subtle and far-reaching than transfer spending.4.5 How Housing Enters the Tax SystemTaxes can be divided into those on income, consumption, wealth andPeterson, (1991> p 57.52transactions. Housing could enter each of these tax bases. A landlord’s incomefrom rent, owner occupier’s income (the imputed rent), capital gains (incomefrom sale of housing property) can all be subject to taxation. The consumptionof housing services by all households, whether paid for through rent orreceived in kind, can be taxed. Residential buildings are one of the singlelargest component of net personal wealth and their property value is subjectto wealth tax. Transactions involving transfer of property are registered onpayment of stamp duty.Taxation of housing is difficult because its true economic costs arepoorly measured by cash flow payments. Cash flow costs of housing may combinethe purchase of both current consumption and of an investment asset. Housingcosts may also be hidden, in the form of opportunity cost of an owners’ equitystake in a house, or depreciation that only becomes apparent over a longperiod of time. Returns from housing often come in kind (as imputed rents) oraccrue over long periods (as capital gains) with only infrequent transactions.The effects of tax concessions or subsidies may be capitalized in houseprices, meaning that current recipients are not the true beneficiaries fromthem.Housing tax expenditures (HTE5) are an important source of housingsubsidies. They have frequently evolved along with taxation systems, ratherthan being specifically designed to aid housing consumption or production. Theincreasing severity of constraints on government budget deficits has elevatedthe issue of HTE5 beyond that of mere academic curiosity. Some governmentshave sought to curb their growth by reforming the tax treatment of housing.64Hi11s, (1991)53In the case of owner-occupied housing, the definition of a taxexpenditure requires the identification of the normal tax treatment accordedto comparable assets or goods. Housing could be considered either aconsumption good, an investment asset or a financial asset. The way in whichhousing is given favourable tax treatment depends upon the category in whichhousing is placed.In analyzing housing tax expenditures, economists have tended to treathousing as an investment asset, in recognition of the fact that the taxablecapacity of the owner-occupier is greater than that of the individual with thesame money income, who is not a home-owner, but pays rent out of taxableincome. This is because the house of the owner occupier is an asset thatcould, if let, generate a money income. In that event, the owner-occupierwould be on par with the tenant, in having to pay for rental accommodation,but with greater money income, and liability to pay more tax. Also, taxationsystems will distort the allocation of resources if they are not neutralbetween different types of expenditure. Increasing attention has been devotedto allocative distortions between owner-occupation and the private rentedsector, and the ability of the housing sector to appropriate funds andresources that would otherwise have been channelled into capital investment inthe industrial sector. This suggests that owner occupied housing and otherinvestment expenditures are sensitive to relative rates of return, and a taxsystem seeking to minimize distortions should, therefore, accord housing thesame tax treatment as other investment goods.In traditional neo-classical economic models, perfect mobility ofcapital and labour is assumed. Capital flows into the tax subsidized sector inresponse to higher post-tax rates of return, and output increases until post54tax rates of return across the economy are equalized by price adjustments. Ifthere is no balanced reduction in government expenditure to offset reduced taxrevenues, and if productivity levels in the tax subsidized sector are lowerthan the rest of the economy, there may be a detrimental effect on the long-run growth of national output. However, Wood (1990) states that such concernsabout the “crowding out” of industrial investment by the housing sector, areunwarranted, unless productivity levels in the housing sector are relativelylow. Econometric estimates using annual data from Australia from 1956-1985 donot indicate any “crowding out” of industrial capital, thereby not suggestinglower productivity levels in the housing sector65.There is a potentially significant influence of HTE5 on the governments’balanced budget. They tend to grow automatically with inflation, interestrates and real incomes and thereby erode tax revenues. There is littleinformation on the cost of HTEs to governments in terms of revenue loss.Available evidence suggests that in USA the cost of HTE5 is significant andhas grown rapidly during the 1980s. In US the budgetary cost of HTE was $49billion in fiscal year 1988 as compared to direct budgetary outlays for lowincome rental households of $11 billionHTE5 erode the tax base and thus affect governments’ budget deficits.They also affect allocative efficiency, by influencing relative rates ofreturns on housing assets and consequently changing the behaviour ofhouseholds and firms. Equity is affected, because they alter the relative tax65wood, (1990)(1990) p 55.55burden among individual taxpayers, and between occupiers and tenants67.There are conceptual problems in estimating the cost of taxexpenditures. If they are ignored direct public expenditure totals aremisleading, but replacement of tax expenditures by direct expenditure isdifficult if they are not recognized as subsidies. HTEs are generally appliedin the private housing sector, and are directed at consumption and provisionof owner occupied and private rental housing. They have potential effects atthree levels in the economy: a) in the national economy- by raising the rateof return on housing, they can reduce investment in other assets, such asbusiness and thus negatively affecting employment; b) in the housing sector,by encouraging tenure shifts towards owner-occupation, and increased housingconsumption and production; and c) in the urban housing market throughunintentional but explicit impacts such as urban sprawl, income segregation inresidential areas, population loss in central city areas and municipalgovernment fiscal problems68.The formal incidence of HTE5 tends to be regressive69, as with aprogressive tax rate structure, any given tax exemption or allowance generatesa larger absolute reduction in the tax burden with rises in income. Also asthe choice of owner-occupation has a positive income elasticity, a largerproportion of owner-occupiers fall in the upper income groups. The size of atax exemption or allowance tends to be directly proportionate to the incomeof the household.67Wood, (1986) p 9.68Boleat, (1986)69Wood, (1986)56As for the effective incidence of HTEs; the beneficiaries are purchasersas they are partly capitalized into house prices. This increases their cost togovernments, because higher house prices increase the size of those housingcosts and sources of housing income that are accorded tax allowance and taxexemption status. Higher house prices also lead to the requirement of a largeramount of subsidy needed to be given to lower income groups for housing.Generally all types of housing tenure are subsidized through HTEs, andtherefore households have an incentive to switch from non-housing expendituresto housing expenditures. The regressive nature of owner-occupied HTEsencourages higher income households to demand more housing, while preferentialtax treatment of this tenure encourages growth in owner occupation at theexpense of rental tenures. There may also be differential spatial effects.Since the demand for the quality and environmental attributes of housing isincome elastic, demand may be greater in lower density areas such as suburbs,thereby encouraging urban sprawl.Housing is a significant component of the macro-economy. In nationalcapital markets HTE5 can be the source of crowding-out pressures by raisingthe rate of return on housing assets. Housing would then be attracting financethat would otherwise have funded private sector investment. In labour markets,HTE5 may have a detrimental impact on labour supply, if erosion of the taxbase requires increases in marginal tax rates to maintain revenues.Tax expenditures cause the demand for housing and house prices to risein the short term70. In the long term, house prices are moderated by anexpansion in supply. Tax provisions favouring owner occupiers increase the70wood, (1986) p 21-22.57proportion of owner-occupied housing in the housing stock, and expand thehousing stock in the long term. House prices and production are increased moreat the upper end of the market, and upper income households will exhibit agreater propensity to become owner occupiers.HTE5 may ultimately subsidize general consumption rather than housing,if households repeatedly realize their equity holdings in order to increaseconsumption expenditures. The secondary impacts (particularly, the degree ofcapitalization) of HTEs that arise as a result of behavioral changes by marketparticipants, are of critical significance to a precise measurement of theeffective incidence of tax benefits at different income levels. The filteringprocess has been used to justify the use of HTEs to improve housingopportunities of low income groups; but there is no evidence to support71thisIn principle HTEs can have the same macro-economic consequences as anequivalent direct subsidy program. They can encourage urban sprawl, but otherfactors such as improvements in transportation technology, real income growthetc. can be considered more significant in this respect. Income segregationand polarization in urban housing markets are frequently cited as a product ofthe unfettered operation of market forces. However, government interventionsmay lead to polarization and income segregation, if other impediments totenure choice preclude entry by moderate to high income groups into rental72tenures4.6 Significance of The Tax Expenditure Concept to Housing Policy71Wood, (1986) p 24.(1986) p 25.58The conceptual and measurement problems associated with tax expenditureshave tended to preclude their close scrutiny. This is particularly true in thecase of HTEs, as the consideration of taxation policy is examined separatelyfrom the administration of government housing programs. Often the HTEs haveemerged as the tax system has evolved, rather than being designed to meethousing policy goals. Thus, HTEs are considered73 to be the source ofunintended impacts. This perception raises important issues for policydiscussion, as it reflects a conflict between the principles and practice oftaxation, the goals of housing policy and macroeconomic performance.Tax allowances can be invoked in respect of either acquisition costs oroccupancy costs. Acquisition costs are those that the purchaser must incur insecuring housing stock by purchase, and include transaction costs, down-payments, mortgage interest and principal repayments. Occupancy costs areincurred in the process of consuming housing services yielded by the housingstock purchased and, include rates payments, depreciation, utility charges,maintenance and repair expenditures.Some countries, such as UK, concentrate tax allowances almostexclusively on acquisition costs. This may be detrimental to the maintenanceand improvement of the existing housing stock, as the pattern of taxallowances encourages households to choose newly constructed dwellings withlow occupancy costs. Correcting this imbalance may encourage demand for olderhousing and stimulate maintenance and improvement. The importance attached tofurthering maintenance and improvement of the existing housing stock, hasprompted some OECD governments, such as France, Ireland and Sweden to73wood, (1990)59introduce new tax allowances designed to promote these objectives74.4.7 Tax Expenditures and Housing Finance MarketsMany governments have introduced favourable tax provisions designed topromote the households’ ability to make down payments for house purchase75.These provisions operate in combination with special savings schemes operatedby HFIs. Preferential tax treatment of savings schemes commonly takes the formof tax exemptions accorded to the interest return and bonuses received by thesavers. Though regressive in their formal incidence, these provisions enableHFIs to attract funds at a lower cost. This benefit can be passed onto thehome-owner in the form of low interest mortgages. In some countries, such asAustria and France, the bonus and HTEs are critical to the system’s ability toattract new entrants, which is necessary to meet outstanding loancommitments76.Non-contractual savings schemes, such as those operated in Canada, carryno loan entitlement. They represent an attractive method of tax-free saving tomeet down payment requirements. By limiting the access to tax-favoured schemesto prospective home purchasers (perhaps first-time), tax shelter possibilitiesare restricted.There are potentially important repercussions of HTE5 for the housingfinance market77. These arise because a HTE will increase demand for housingand this in turn will raise the demand for mortgages. In general, HTEs will beWood, (1990)75Boleat, (1986)76 Boleat, (1986)Boleat, (1986)60partly capitalized into the interest rates prevailing on the assets andliabilities of HFI5. The extent of capitalization will depend upon thecompetitiveness of the housing finance market.4.8 curtailing Tax Efficient Housing InvestmentPrivate rental housing in some countries, such as USA, has attractedsuch favourable tax provisions, that housing assets are being used as a meansof sheltering other sources of income from taxation. This is costly in termsof revenue forgone, and is also a source of allocative distortions andefficiency losses. These circumstances are particularly evident in countriesthat use HTE5 to encourage private landlords’ acquiescence to rent controls.This is done by allowing deduction of operating costs from taxable income andexempting capital gains from taxation. With stringent application of rentcontrols, it is common for private landlords to incur losses that can be usedto shelter other sources of income. If rents rise so that losses areeventually eliminated, tax burdens can be minimized by taking advantage offavourable capital gains provisions, and selling to owner-occupiers.4 .9 Other Forms of Government InterventionSubsidies in the form of low interest loans may lead rents to falleventually as more new building occurs; but eventually house prices will rise.Program funding is generally insufficient to provide subsidized dwellings forall eligible households, and therefore can lead to inefficient allocation ofsubsidized housing. An increase in the provision of housing at below marketrents by non-profit housing agencies can result in lower house prices andrents in the short run, resulting in the eventual decline of the provision ofother housing. If rents are set at historic cost levels, there may beconsiderable variation in the rent paid for equivalent housing. Such61administered rents provide no incentive to utilize the housing stockefficiently.Application of rent controls also results in administered rents and ifapplied consistently across the rental tenure sector, the stock of rentalhousing will deteriorate and decline. This will be accompanied by a rise inhouse prices and an expansion of owner-occupied housing, resulting in higherland prices leading to the realization of holding gains by the owners of landupon which new housing is built78.Home improvement subsidies reduce the cost of augmenting the existingstock of housing. If the price elasticity of improvement activity is low,there will be little net addition to the housing stock. The demand for, andprices of properties eligible for improvement subsidies may rise. Thecomposition of net additions to the housing stock is likely to change infavour of conversion and renovation to the existing housing stock.4.10 Comparison between Tax Expenditures and Direct SubsidiesUnder strict assumptions, taxation, subsidies and direct controls areequally efficient79. If the production of a good results in costs to otherfirms and households nearby, the government may impose a tax on the producerthat reflects the social costs at each level of output. In this wayexternalities are internalized and the decision makers will modify productionin line with the true marginal social cost. Output will be reduced because theexternality is taken into account and weighed against the benefits of78This form of intervention is regressive, as it puts more income in the hands of propertyowners, who are already better of f; at the expense of lower income tenants, who due to thecontraction in the supply of rental stock, pay higher rents and/or make do with less housing.79witehead, (1983)62production. Equivalently, a subsidy can be given as an incentive to curtailproduction in cases where social costs offset private benefits. In principle,the only difference lies in distributional effects, in the first case theproducer of the external costs suffers a reduction in income, while in thesecond, the community rewards him for not causing additional costs to thesociety. Where the externality is costly, taxation is usually regarded as amore equitable approach, unless there are additional objectives ofredistribution or the provision of merit goods. Taxation also provides auseful source of income, although its use may cause further problems ofefficient allocation. Subsidies present similar allocation problems andrequire financing from somewhere. This presents a major problem for allgovernments, particularly in developing countries. Housing tax expendituresencourage private sector participation rather than government-centred decisionmaking. By offering financial incentives on a voluntary basis, they avoid theuse of coercive instruments of government intervention. Alternative indirectand direct subsidy programs are more likely to involve government controlsover the provision/production of goods and services; and so run the risk ofreplacing market forces and inducing the withdrawal of private sectorparticipation, as compared to the cooperation encouraged by HTEs.The provisions of tax expenditure programs are simpler and easier toadminister, as no new bureaucracy is required for the purposes ofimplementation. Further, as these programs are not subject to regular reviewand scrutiny, they are not changed frequently. They may be viewed as helping6380to preserve the stability of a subsidyHouseholds respond more favourably to tax subsidies than to directsubsidies. An advantage of benefits paid to households through the tax systemis that they are less likely to be made automatically. In contrast, directsubsidy programs tend to require a more time consuming and “visible”application process, which highlights the individual’s receipt of subsidy.This can stigmatize potential claimants and induce a reluctance to initiatevalid claims, thereby lowering take-up.Tax expenditures can, in principle, assist the private rental and owner-occupier tenures equally81. Tax expenditures favouring the rental sector arenormally indirect forms of assistance provided in the form of incentivesencouraging the construction of new rental housing. Such measures offer theopportunity of designing more horizontally equitable HTEs. If horizontalequity is to be preserved, the housing allowance programs should be based on aconsistent measure of housing costs across tenures.Tax expenditures are seen as a form of government spending available tomeet objectives that the government considers to require financial assistance.Any financial aid or incentive program may be written either as a taxexpenditure or as a direct program, or a combination of both. The choicebetween tax expenditures and direct programs is not an easy one. Very littleis known about just what factors influence such a choice or whetherWood, (1986) However, this is not true in the Indian context, as tax laws, especiallythose that confer tax expenditures are changed frequently, presumably after review and reexamination.81Smith, (1981) p 456.64governments recognize that a choice is possible82.Several negative characteristics are attributed to tax expenditures thatare equally applicable to direct spending programs also:1. They pay recipients to engage in activities that they would engage in anyway, that is, they have a windfall effect.2. They distort the choices of marketplace and the allocation of resources.But, if it was not so, they would have only a windfall effect. The governmentassistance 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 forecastaccurately.5. They allow taxpayers to decide on their own eligibility. This self-determination of eligibility, is present in direct spending programs also,where the beneficiary must apply for assistance.Some other aspects of tax expenditures are either absent or areinsignificant in direct spending programs. The prime example of these is the“Upside down effect”83. Tax expenditures work to the greatest benefit ofpeople with the highest marginal tax rates. It is very unlikely that a directtax program would be so structured. The upside down effect may be eliminatedor mitigated in many ways; by using a method such as a taxable credit againsttax; or by using a tax expenditure that vanishes at a certain income level andso benefits only people below that income. A refundable tax credit may counter82surrey and McDaniel, (1985)83surrey and McDaniel, (1985).65the effect of exclusion of non-taxpayers. Almost by definition, taxexpenditures are dependent on the regular tax rate structure, so, when taxrates are reduced, they also go down; when tax rates are increased, theybecome more expensive84. Tax expenditures enjoy lower visibility, as they arewoven into the tax provisions. Tax expenditure budgets, which acknowledgetheir presence, are not widely circulated. Focusing on the tax aspect of thetax expenditure permits debate to shift away from the real issues.It is difficult to predict the use of tax expenditures. They can be usedto provide tax shelters. Most tax expenditure provisions initially have anarrow focus, but tax professionals soon learn to use them as tax shelters.This results in non-productive (for the economy as a whole) expenditure onmiddlemen- investors, brokers, lawyers, accountants and tax planners, thusencouraging rent-seeking activity. Tax planning, resulting in tax avoidance,somehow does not encounter similar societal censure as welfare fraud (which ismisuse of direct subsidy); and thus goes largely unchecked. Tax expendituresare often viewed as escape routes for favoured individuals and corporations.Tax expenditures are largely responsible for the complexity of tax lawsand tax administration. They also lead to confusion over responsibility forprograms. If a tax expenditure was rewritten as a direct spending program, itwould be in the operative jurisdiction of the appropriate agency in theexecutive branch- without involving the treasury. But as tax expenditures theyare administered by the treasury (or the finance ministry) which may lack therequired expertise, and to obtain this expertise has to divert its resources.This results in, say, a housing tax expenditure being evaluated not by housing84This again emphasises their regressive nature.66experts, or for its value in providing housing, but from the perspective of atax administrator. Better co-ordination between the treasury and theappropriate agency, at least at the time of formulating and evaluating the taxexpenditure, can ameliorate this situation.Tax expenditures enjoy acceptability as subsidies in a capitalisteconomy, whereas direct subsidies from the government are viewed as beingsocialist in nature. They are more securely embedded than direct programs andare thus expected to remain in effect longer. Their implementation is madeeasier by the fact that they utilize an established framework of (tax)administration.67CHAPTER FIVEHOUSING TAX EXPENDITURES IN INDIAThis chapter discusses the housing tax expenditures used in India. Thefirst section, 5.1, discusses the nature of India’s fiscal policy. Section 5.2describes the various tax policies relating to housing in India.5.1 IntroductionIndia’s fiscal policy is motivated primarily by the need to mobilizeresources for economic development. It also focuses on social equity,maintenance of economic stability, and allocation of resources according to apredetermined scheme of economic priorities. This policy framework originatedwith the first Five-Year plan (1951-56) and developed in new directions as theplanning process became complex and pervasive. Under Indian conditions, thefiscal policy has a longer reach and a different connotation than in othercountries, perhaps because it is a principal instrument to augment publicsaving, influence private saving both in magnitude and disposition, financepublic investment, and determine the pattern of income distribution85.The Indian investor is fiscally oriented and a very large proportion ofsavings accessed by the government are the result of fiscally orientedschemes. The availability of fiscal concessions determines to a significantextent the resource flow to a particular sector or activity. By offering avariety of tax incentives, Indian fiscal policy has influenced the allocationof disposable income of the household sector, the corporate sector, and thenon-incorporated enterprises. It has been used to induce the household andother parts of the private sector to hold their savings in desired investment85Khatkhate, (1991) P 254.68instruments86. Some investments enjoy tax preferences to such an extent thatthe resulting return to the investor is extremely high.5.2 Taxation Policies Affecting Housing in IndiaPh1 ‘ 1 . Trn ri Tnd t,f h,-iiqinrt nrl rd-hr———— —.—. ------- —-- —--Investment Interest Return Capitalpayments on gainsamountsborrowed forinvestmentOwner- 20s allowed Tax-relief Imputed rent is Taxedoccupiers as tax upto Rs. taxedcredit* 10,000 perannumPrivate 20 allowed Tax-relief Rents taxed TaxedLandlords as tax upto Rs.credit* 10,000 perannumOther Exemption for Interest is Taxed- after Taxedbusiness specified fully allowinginvestment sectors deductible depreciationOther No relief No relief No Tax No TaxconsumptionOther No relief Fully Tax relief upto Notsavings- such Deductible Rs. 7,000 per applicableas bank annumdeposits,approvedsavingsShares Exemption for Fully Dividends Real gainsspecified deductible taxed- relief taxablesectors allowed for newapprovedcompaniesSource: Constructed with information from the Indian Income Tax Act, 1992, andsubsequent amendments.** The total investment eligible for tax credit is limited to Rs. 10,000per year.Table 5.1 highlights the features of taxation relating to housing inIndia. Such policies influence the housing situation for taxpayers only.Considering that less than one per cent of the total population pays income86 by allowing interest paid on them; and sometimes the amount invested also; to be deductedfrom the taxable income.69tax (only 8 million out of a population of 900 million are income tax payersin 199487), tax policies that give a fillip to direct investment in housingcan only have limited impact.Increased housing activity has a large employment and skills multipliereffect in addition to backward and forward linkages with related industries,such as, construction materials, furnishings, paints, accessories and consumerdurables. As most housing construction in India is done manually by unskilledor semi-skilled labour who come from the lowest income group, fiscal policiesto boost housing activity are sure to have a positive effect on the income ofthe poorest sections.To encourage investment in housing for low-income groups, who aregenerally not income tax payers, weighted concessions are given to employerswho invest in housing for their employees. This policy has improved housingconditions of factory and plantation workers. However these workers and theirfamilies are assured of housing only as long as one of their family members isemployed in that concern. Also, as such housing is not owned by the peopleresiding in them, there is very little contribution by the residents inimprovement and maintenance of the housing stock.To ameliorate the housing situation of the urban poor, government has toeither itself, or by provision of finance to the private sector, ensurebuilding of housing on a massive scale. For this, the main requirement is offinancial resources that can be raised by channelling the savings ininstitutions set up specifically for financing housing. If their income istaxed at concessional rates then these institutions can provide housing loans87T1-ie Economic Times (10th February 1994)70at lower interest rates. Deposits to such institutions can be attractedthrough tax rebates and these deposits can be used to finance building orpurchase of houses.Ph 5.2: Home T.,, r,,11r- lm inAmount of loan (Rs.) Annual Rate ofLoan as a multiple of interest88 (%)accumulated savings4 times Upto 50,000 10.53 times 50,001-100,000 12.02 times 100,001-200,000 13.51.5 times above 200,000 14.5Source: Rao, (1991) p 74.The Home Loan Account (HLA) Scheme is a loan-linked saving schemeintroduced by the NHB, which was set up in July 1988 to fill the lacuna in theIndian housing finance system that has been a major inhibitor in the growthand development of the housing sector. The HLA scheme was introduced from July1, 1989. It is basically a deposit linked loan scheme that offers users apositive real rate of return of 10% (compounded annually), tax concessions onsavings and an assured loan (with tax concession on installment repayment) forhouse building after a period of 5 years (3 years in the case of purchase of ahouse/flat in projects financed by NHB). Any individual, not owning a houseanywhere in India can open a HLA with any branch of designated scheduledbanks. The account holder has to save regularly for a period of 5 (or 3) yearsafter which a multiple of accumulated savings can be availed of as a loan. AsTable 5.2. shows, the scheme is favourable to lower income groups, who areeligible for getting a larger multiple of their savings as loan, and at a88The annual interest rate charged by banks in India was 18 in 1991. The indigeneousbankers and informal credit sources give mainly short term loans on which they charge monthlyinterest at rates upto 5 The annual compounded rate of interest on such loans may be as high as75.71lower rate of interest.The savings under the HLA scheme qualify for tax concessions. Twentypercent of the payment of principal of the loan (up to Rs. 10,000 per annum)is eligible to qualify for a tax credit under section 88 of the IT act.Interest on the loan is eligible for deduction in the computation of incomefrom house property under section 24 of the IT act. Similarly the amount ofaccumulated savings under the HLA Scheme, together with the interest is exemptfrom Wealth Tax (WT), subject to the overall ceiling of Rs. 500,000.The housing situation in India for the middle income groups89 is alsofar from satisfactory. Making interest on mortgages tax-deductible, fully asin the USA, or upto a certain limit as in UK.; will give a boost to housingactivities. This will directly increase investment in housing for the middleincome groups and will benefit the poor through the process of “filtering”whereby the total housing supply increases and vacated middle incomeaccommodation becomes available to the poor.Rationalization of stamp duties and registration fees9° on residentialproperty transactions would encourage their registration and perhaps reducethe influence of parallel economy on this sector. The parallel economy issizable and is disproportionately present in the housing sector. Residential89 The middle income groups in urban areas have income ranging from Rs. 12,000-50,000 peryear. They usually pay income tax, which is levied above the threshold income of Rs. 35,000 peryear (from fiscal year 1994-95) . (The main reason for only 1% of the total population being taxpayers, is that agricultural income (primary source of income for about 70% of the population) isexempt from IT and WI. Also income of tribals residing in tribal areas is exempt. This accountsfor another 7-8% of the population. So out of the remaining 22-23%, 1% pays IT. If peopleemployed in the informal sector are also excluded, then the population that is taxable, works toabout 10%. So, it can be said that 10% of the taxable population pays income tax.)90mese are charged on the market value of property. However, property values are generallyheavily understated.72property and land are among the main assets in which speculators and blackmarketeers invest their undeclared profits. A fiscal and municipal taxationpolicy, including a levy of tax on vacant urban land and residential propertyin order to curb speculative activities, will result in increased supply ofland and buildings and will lower their prices.In India, there is a shortage of supply of building materials, such ascement and steel. The prices and supply of these items are controlled by thegovernment. There is need for rationalization of the structure ofmanufacturing duties levied on these items to ensure increased production andsupply. As the supply of traditional building materials, such as cement,steel, bricks and timber is likely to remain limited and subject to thevagaries of sudden price hikes, a concerted and organized effort to providealternative building materials is needed. Promotion of use of non-conventionalmaterials, like agro-industrial wastes can reduce cost of construction, and ismore environmentally friendly than traditional building materials. For this,tax concessions similar to those given to institutions engaged in scientificresearch should be given to institutions involved in research for alternateand low-cost building technology.Several tax incentives and concessions have been given by the governmentto individuals and companies for housing, but they are of peripheral natureand their real value has diminished due to inflation over the years. Theserequire re-examination with a view to enlarging the scope of existing taxconcessions and introducing new fiscal measures to attract private andcorporate savings and expenditure on housing.HUDCO and NHB have been allowed to issue capital gains bonds91, and this91capital gains are invested in bonds, or fixed deposits carrying preferential tax treatment73should contribute to a faster rate of growth of the housing finance sector92.The amount invested in these bonds carries a preferential rate of interest,and if the sum invested was out of sale of capital assets, the amount investedcould be deducted from taxable capital gains. However, these bonds have becomeless attractive, as in 1992, the section providing exemption for capital gainsreinvested in capital gains bond was removed from the statute.The 1992 Central budget withdrew many fiscal concessions earlieravailable to the housing related activities and house property income. Theannual deduction of Rs. 3,600/- allowable from the annual value of a houseproperty in respect of new residential units for a period of five years fromthe date of completion has been withdrawn. The facility to set off loss fromhouse property against income from any other source was also withdrawn. Thecarry forward loss of any year from house property is now allowed to be setoff only against income from house property of subsequent years. The loss inincome from house property arises mainly from the imbalance between high ratesof interest payable on housing loans and realization of rent (in case ofrental property) . This imbalance persists in the initial 10-12 years ofborrowings whereafter rental income and interest payment match. Under the newprovisions, the borrower would be required to wait for an inordinately longerperiod to avail of the facility to set off the losses incurred in earlieryears. This is likely to affect the level of future investments in housing.Total exemption from tax on capital gains arising out of transfer of aresidential house property where the total sale consideration was upto Rs.and/or rate of interest.92 Buckley et al, (1989)74200,000 and proportionate exemption on sales exceeding Rs. 200,000 wereallowed till 1992. Now these exemptions are withdrawn; and residential houseson sale are taxed for capital gains like other assets. These concessions havebeen withdrawn as a part of rationalization of tax laws; and their effect hasbeen nullified to some extent by lowering of overall tax rates. However thewithdrawal of such concessions specific to investments in housing, means thatnow the housing sector competes for investment along with other sectors.Considering that less than 1% of the Indian population pay income tax, and thetax threshold is fixed at a very high level (Rs. 35,000 as against annual percapita income of Rs. 10,000); the negative effect of such withdrawals will beonly 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, theprice of housing may come down, making it more accessible to the middle andlow income groups. Also these groups will also have greater access to loansfor housing, as the rich will no longer have the incentive to take largehousing loans as the interest deduction from these has been limited, to Rs.10,As of 1993, one residential house is exempt from Wealth tax. Transfersof houses are subject to payment of Stamp duty (at the rate of 3%); capitalgains tax and gift tax like other assets. ny allowance received by the tenantfor payment of rent is not included in taxable income. This deduction is notavailable to persons living in their own house. To calculate income fromhouse property, annual value, which is the actual rent received or the sum forwhich the property can be rented for, less property tax paid (if rented) is93me limit of Rs. 5,000 for deductible interest has been raised to Rs. 10,000 in 1994.75taken as the base. Other deductions, such as, a sixth of annual value forrepairs, insurance premium, ground rent, land revenue and interest paid onborrowed capital- upto Rs. 10,000 annually, are allowed while computing thetaxable income.From business income, a deduction of up to 40% of total income isallowed, for reserve created for investment in a financial corporation, or apublic company engaged in providing long-term finance forconstruction/purchase of residential houses.A deduction is also allowed in respect of part of the rent paid, in caseof persons living in rented houses. A tax credit is available at the rate of20% of payments made (upto Rs. 10,000) for any installment paid for financingpurchase or construction of residential house property, repayment of housingloan, stamp duty and registration fees.Property tax is the major instrument for mopping up unearned increasesin land values. The municipalities in India administer a municipal propertytax and the rates vary. A few cities, such as Delhi and Madras, also taxvacant land. Most Town and Country Planning Acts have specified bettermentcharges, in areas where some improvement has been brought about through adevelopment scheme by a public authority. This is a difficult levy to assessand is generally disputed. A tax on unearned increase in property prices isalso levied at the time of transfer, the principle being that half theappreciated value be recovered by the public authority94.94Ribiero, (1985). The stiff penalty is imposed to prevent people from profiting by sale ofproperty allotted to them at concessional rates by the government. However, this is generallyavoided by understating the resale price- resulting in a double loss for the government- loss ofstamp duty (calculated as a percentage of the sale price); and creation of black money (throughunreported income)76In India, owner-occupiers and private landlords are treated in similarways. However, in terms of tax relief, residential property investors get alower return on their investment, as their income, whether actual or imputed,is subject to lesser allowances than business investments. For example, in thecase of business assessment, interest paid, depreciation and other expensesincurred are fully deductible; while from house property income, depreciationis not allowed, and expenses such as interest, repairs, cost of collection ofrent etc. are subject to ceiling limits. Moreover while business losses areallowed to be set off against other incomes of that year and subsequent years,losses from house property income are restricted and can be set off onlyagainst income from house property in subsequent years. This discriminatorytreatment of house property income reflects the thinking that house propertyincome is not fully reflected in monetary terms of earned or imputed rents,but the return of house property also includes intangibles, such as thesatisfaction, security and status obtained from owning a house. Rents in theIndia are not a reflection of the value of the property, as the rate of returnis low, but the capital gains realized on transfer of property are very high.The only tax advantage house-owners in India have over their businesscounterparts is that they can claim a tax credit for a part of the amountspent towards purchase or construction of the house. The incidence of thisincentive is not regressive among tax-payers, as the amount of investment, isnot deducted from the taxable income, but a tax credit at the rate of 20% isgiven95. Clearly this step is in the direction to encourage investment intohousing, rather than consumption and other business assets.However, non-tax payers, do not get any tax credit refund.77Revisions to the income tax code (Sections 80L-exemption of interestearned on certain deposits; 24(i) (vi)- deductibility of interest paid onhousing loans; and 80CC- exemption of amount invested in the equity of certaincompanies) would make certain deposit services offered by HFIs more attractiveto their customers, thereby enhancing their ability to raise funds96. The setof tax laws that affect the distribution of financial savings in India arevery important to a firm’s ability to mobilize resources. They are also verycomplicated and difficult to evaluate in isolation. e.g., interest earnings ofupto Rs. 7,000 per year, paid on deposits of upto Rs 140,000 with financialinstitutions are eligible for tax deduction, while deposits with the UTI are97eligible for another Rs 3,000 deductionNHB had announced in 1991, a Voluntary Deposit Scheme for mobilizationof black money98 and its partial use for construction of houses for the poor.Under this scheme 40 percent of the total collection of over Rs. 800 millionare available for providing housing for the poor. Though the final outcome ofthis scheme in terms of the actual numbers of housing created for the poor isyet to be evaluated, the theory of utilizing black money for augmenting thehousing stock is innovative and useful as it proposes to bring about redistribution of income.Few Indian families have to concern themselves with tax provisions;96suckley et al, (1989) p 23.97Buckley et al (1989) p 24.98Black money is the income not reported for tax purposes. The Voluntary deposit scheme wasan amnesty program for one year, to allow declaration of hitherto unreported income. ?unountsdeposited in the notified account with NHB, were taxed at the highest marginal rate, but nopenalty or interest was charged. Similarly no questions were asked regarding the source of theincome.78since most household savings are of a size not affected by tax provisions. Foraccess to household savings the most important taxes are not taxes at all.They are the implicit regulatory “taxes” that affect and constrain return andmaturities of deposits and the ability to provide various types of financialservices on a monopolistic basis; e.g. life insurance. The effects of thesekinds of taxes are very difficult to infer99. For the allocation of savings ofcorporations and the profitability of competing financial institutions, taxconsiderations are more important. However, as Buckley et al (1989) report,they are no less difficult to evaluate.This complicated and multi-layered environment makes it impossible toanswer quantitatively questions such as, which tax regulations are essentialfor ensuring housing financial institutions success in mobilizing resources.Or, which tax code provisions favour the sector at the expense of the economyand vice versa? However, by the same token it is obvious that such acomplicated tax code is not in the best interest of either the housing sectoror the financial system. Hence, rather than trying to perform provision byprovision analysis of relevant tax provisions, taxation issues need to bereformed comprehensively and consistently, along with broader financialreform.99Buckley et al, (1989)79CHAPTER SIXHOUSING TAX EXPENDITURES IN OTHER COUNTRIESHousing tax expenditures in countries other than India are discussed inthis chapter. Section 6.1 describes the HTEs used in OECD countries, whileSections 6.2, 6.3 and 6.4 discuss their presence in Britain, Canada and USArespectively.6.1 OECD CountriesIt is difficult to generalize about what actually constitutes housingtax expenditures (HTE) given the variations in taxation procedures in OECDcountries. OECD member countries may be divided into 2 groups100. The first,corresponding to English speaking countries, are characterized by a heavyreliance on direct taxes applied to income and profits. The second groupexhibits a high ratio of indirect taxes on goods and services to direct taxes,and relatively higher social security contributions. (e.g. Spain, France andGreece) . These differences are reflected in the tax treatment of housingassets, with the former group placing a greater reliance on taxes levied onhousing returns, and the second group concentrating more upon taxes applied totransactions in housing assets and recurrent property taxes.The most common HTE5 afforded for housing construction are exemption ofprofits from corporation tax or granting of preferential tax allowances to theproducers of low to medium income housing. Reduced indirect tax rates, such asValue Added Tax (VAT), are applied to the sale of new housing. In most OECDcountries income from rental housing is subject to personal income tax orcorporation tax. The preferential treatment of deductible operating costs‘00The discussion of fiscal policies in OECD countries is based on Wood, 1990.80constitutes a principal source of tax expenditures for rental housing. Rentalhousing is also exempted from (or is subjected to lower rates of) taxesapplied to real property, and transfer duties.Tax expenditures are a key component of most OECD governments’ policiesto promote home ownership. HTEs for home ownership-saving schemes are deployedeither through tax-free interest and bonuses, or deduction of savings depositsfrom taxable income. In the taxation of imputed housing income and deductionof owner-occupiers’ expenses; most countries allow mortgage interest to bededucted from income for tax purposes, though ceilings and conditions aregenerally applied. The addition of the property’s imputed rental value to theowner occupier’s income is less common. Tax allowances are also invoked bysome OECD countries in respect of expenditures, such as, property taxes,expenditure on energy saving, repairs and improvement expenditure anddepreciation. The taxpayer’s main residence is generally exempted from capitalgains tax. However, this can be subject to various conditions such as reinvestment of the sales proceeds in the purchase of a new residence, and thelength of occupation.The taxation of owner occupiers’ imputed net rental income entailslogistical and political problems. Notional rental income values are based onadministered assessments that require significant policing and enforcementcosts. Since assessed values are generally below market values, and currentexpenses are commonly accorded tax allowance status, the revenue yield tendsto be low. It is also difficult to politically justify the “fairness” of a taxlevied upon an intangible income stream. Prompted by these considerations thegovernments of United Kingdom, France, Ireland, Australia and West Germanyhave abandoned the taxation of imputed net rental income, even though some of81them continue to treat current housing expenses as tax allowances. In theUnited Kingdom, owner-occupiers receive tax relief on their mortgage interestpayments at their highest marginal tax rates on the first 30,000 pounds of amortgage. Under the Mortgage Interest Relief at Source (MIRAS) scheme;households not liable for income tax make mortgage payments net of “relief” atthe basic rate of tax. In West Germany the owner-occupiers can take advantageof a depreciation allowance that amounts to five per cent of the historic costof purchase in each of the first eight years of ownership (the allowance isonly available once and the accumulated aggregate cannot exceed DM 300,000).The United States grants generous allowances to home owners.In contrast, the imputed net rental income of owner-occupiers is taxedin Denmark, Finland, Greece, Luxembourg, the Netherlands, Spain and Sweden.Generally, imputed rent is arrived at as a percentage of the property’sassessed capital value, generally below market values. Exemptions arefrequently employed, further reducing the impact of tax liabilities. Sincecurrent expenses are deductible from assessable income, imputed net rent canoften be negative in the initial years of ownership101.OECD governments have introduced provisions designed to place a ceilingon mortgage interest relief. However this is matched by the introduction ofnew tax expenditures designed to promote new housing construction and housingimprovement and repair.101 Finland typifies taxation provisions in this respect. Since 1973 Finnish home-ownershave been subject to the payment of income tax on net imputed rent. The gross imputed rent is setat 3 per cent of the administratively assessed capital value, which normally lies below marketvalues. Those properties whose assessed capital values is below 215,000 Finnish marks are exempt.Home owners subject to tax, can deduct annual mortgage interest payments in excess of 600 marksand up to 25,000 marks from gross imputed rent. As a result, only 2 per cent of Finnish homeowners were taxed on net imputed rent in 1983. (Wood, 1986).82In some OECD countries, tax expenditures are explicitly granted toprivate landlords in order to encourage their acquiescence with rent controls.Since rent controls depress rent levels, these tax arrangements normallyresult in losses being incurred during the early years of investment, whichmay be deducted from other sources of income. This “negative gearing”represents an attractive means of sheltering other sources of income. Whenthere is positive taxable income from rental housing, owners may avoid taxentirely on housing returns by taking advantage of the exemption of capitalgains from taxation, which becomes available after a minimum possession periodof two years.Most OECD countries treat the capital gains realized on owner-occupiers’principal residences as exempt from taxation. In countries where they aretaxed, deferral provisions nullify their effect. For example, in the US homeowners can defer taxes if the realized gains are put into a more expensivehome. There is also a one-time capital gain exclusion up to a ceiling of$125,000, for owners aged 55 or more. In Sweden capital gains are also subjectto taxation on a deferred basis, provided they are re-invested in the owneroccupiers’ principal residence. In Canada capital gains from the sale ofprincipal residence are exempt, while in respect of other residentialproperties, income tax provisions apply to realized nominal gains, but 25 ofall gains are exempt. In most OECD countries capital gains realized on privaterental properties are subject to taxation, but the practice varies in regardto the use of nominal or real capital gains as the tax base. In Australia,real capital gains are taxed under income tax provisions. Until the 1986 TaxReform Act (TRA), the US subjected the realized nominal capital gains ofprivate landlords to a preferentially low tax rate. Taxation provisions differ83in Germany where capital gains are entirely exempt beyond a minimum possessionperiod of 2 years.All European community countries except Denmark and Britain have localtaxes on property. Britain has a business property tax but abolished domesticrating in favour of a Community Charge or Poll Tax. A new system, called a“domestic tax,” was scheduled to replace the Community Charge in 1993.Recurrent property taxes are levied by local tiers of government in almost allOECD countries. The tax base generally consists of land and buildings thathave been assessed for tax purposes, and the tax is levied at ratesestablished by municipal government revenue needs. As the tax is local, thereis wide variation in assessment procedures both within and between OECDcountries. Some countries, such as USA, allow deduction of property taxes fromassessable income under federal tax provisions.Greece is one of the few countries to include residential property inthe tax base of a recurrent wealth tax introduced in 1982. In response to thepublic’s vociferous reaction, the tax rates have been reduced sharply, andapply to administratively assessed capital values that are deliberately keptbelow market values. Thus the impact of this wealth tax is negligible.Examples of non-recurrent taxes are the stamp duty levies in Australiaand UK, and the transfer taxes payable in Greece and Portugal. Home owners inGreece are subject to a number of non-recurrent indirect taxes (NRIT) to whichmany tax expenditure provisions apply. The NRIT comprise a real estatetransfer tax applied to the sales of residential property, and an inheritance/gift tax that is applied to the transfer of property by means of aninheritance, gifts and parental assistance. Since 1982, the tax base has beenvalued in both cases by administered methods resulting in below market values.84Similar tax provisions with significant NRIT on residential property are alsofound in Portugal, Spain and Turkey.In Canada, France, Germany, Japan and Luxembourg an important aspect ofthe tax treatment of home-owners is the tax expenditures accorded tofacilitate down-payment requirements. Since 1988, USA allows contributions ofupto $20,000 towards a first home savings account to be treated as a taxallowance. In France, post offices, savings banks and trading banks are ableto offer Housing Savings Plans that grant tax-free interest, conditional onthe use of accumulated funds for the purposes of acquiring residentialproperty.The British, Irish and US governments have traditionally protectedspecialist Housing Finance Institutions (HFI5) by means of preferential taxprovisions. The aim of such measures is to bring about greater stability inthe flow of mortgage finance. The specialist US savings and loans institutions(S&Ls) were originally exempt from federal income taxation. This exemption wasremoved in 1951 and replaced by a tax allowance for bad debts, and a maximumtax rate provision. This enabled S&Ls to avoid paying taxes, provided 82% ormore of their total assets were held in home mortgages or US governmentsecurities.Less common among OECD countries is the use of tax expenditures tofacilitate the issue of mortgage backed securities. In the US, state and localgovernment are entitled to issue mortgage revenue bonds, that are tax exempt,and the revenue can be used to fund below-market interest rate mortgages, orthe construction of low-income rental units. Mortgages are targeted on firsttime buyers, on low to moderate incomes, who are purchasing in “economicallydistressed” areas.85Resistance to taxation of imputed rents is on the ground that itrepresents an “invisible” income stream. In an inflationary environment with atax base measured in nominal terms, taxing imputed rent becomes a tax on realwealth. This problem is particularly sensitive issue with respect to housing,as housing equity generally forms the largest component of many households’net worth.Table 6.1 describes the chief features of the taxation of owneroccupiers and private landlords in some OECD countries and India. TheAustralian and Canadian tax treatment of housing assets differs according towhether they are owner occupied (when they are treated as non-incomegenerating consumer goods), or privately rented (treated as income generatinginvestments and taxed accordingly) . UK, Ireland and France exempt capitalgains and the imputed net rental income of home-owners, while allowingdeduction of mortgage interest payments which is inconsistent with the normaltax treatment of either investment assets or as consumer goods. Thus, homeowners are unambiguously granted preferential tax provisions as compared withprivate landlords. In practice, the same situation prevails in USA, as thedeferred basis of taxation of capital gains and a generous one time exemptionmeans that most home-owners do not incur a liability. The Netherlands andSweden are distinctive in having a consistent and more tenure-neutral set oftax provisions, treating housing assets mainly as investment goods. India,also treats both landlords and owner-occupiers in a similar manner, except fornot levying any wealth tax on owner-occupied houses.86Table 6.1: P--,,r, of Owner-”.’1and D,l-1 U,,.,,.r in T,-.-I4 nd 1nt-1—--.-,- -.-‘-‘- - ‘-‘-.----- —-OECD CountrtPrefere Transfe Allow Tax Tax Annual Recur-Country ntial r Tax Deducti impute Capital Wealth renttax or on of d / Gains Tax Properttreat- Stamp Mortgag Net y Taxment to Duty e Rentalsavings Interes IncometINDIA Both Both Both Both Both Land- BothlordBAUSTRALI None Both Land- Land- Land- None BothA lords lords lordsCANADA None Both Land- Land- Land- None Bothlords lords lordsFinland* No No Yes Yes No No NoFRANCE Owner- Both Both Land- None Both Bothoccupie lordsrsGREECE None Both Both Both None Both NoneIRELAND* No Yes Yes No No No NoNether- Both Both Both Both None Both BothlandsSweden None Both Both Land- Land- None Bothlords lordsUK None Both Both Land- Land- None Bothlords lordsUSA None None Both Land- None Both BothlordsSource: Adapted from Maclennan and Williams (1990). Information about India isfrom The Indian Income Tax Act, 1992.* Relating to owner-occupiers only.The Greek housing tax provisions are distinctive and are representativeof that group of countries which rely more heavily on indirect taxes andsocial security levies. Though both homeowners and private landlords aresubject to the same array of taxes on housing assets, home-owners are grantedsignificant tax allowances and part exemptions.Recent reform measures in OECD have not, in general, changed housingsubsidy provisions towards a tenure neutral subsidy/tax system. The new taxprovisions introduced in recent years reflect concerns ranging from the cost87of tax expenditures, to using tax expenditure provisions in order to favourparticular purchasers, activities or segments of the housing stock.Measures designed to curb foregone tax revenues have a disproportionateimpact on high income groups, as they generally involve limitations on theuse of tax allowances. Some countries’02 preclude the application of taxallowances at the tax payer’s marginal rate. In Greece, reforms introduced in1988, restrict the tax benefit from mortgage interest tax allowance to thebase of the income tax rate scale. Similar flat rate deduction provision hasbeen employed in France since 1983, with rebates on mortgage interest chargescalculated at the flat rate of 25 per cent. The introduction of a ceiling onthe extent of allowable cost deductions is increasingly common. If this is notadjusted in line with inflation the real value of tax allowances will begradually eroded; resulting in a convenient way of phasing out tax allowances.Tax credits are also used to both curb the cost of tax expenditures, andameliorate their regressive nature.The situation regarding fiscal policies that affect housing in threeOECD countries that publish tax expenditure budgets, and where such policieshave been studied and analyzed is discussed next.6.2 BRITAIN“Housing in Britain is the subject of a web of subsidies, benefits, andtax concessions; which has grown steadily more tangled as the years have goneby.” 103In Britain, housing as an economic sector has a very significantmagnitude. It represents 4 per cent of national output; housing construction102WOOd (1990)103 Hills (1991) p 3.88employs a million people and housing makes up a fifth of the gross investmentin fixed capital in the economy. It has been recognized that the housingmarket is driven by economic change, particularly in terms of incomes,interestrates and household formation104.T11 6.2: i, TTV Housinci and Other Ti,r’,,mInterest payments Return Capital gains( cash! imputed)Owner-occupiers Tax-relief upto Tax-free imputed Tax-free30,000 rentPrivate Landlords Interest is tax Rents taxed-no Real Gainsdeductible deduction for taxabledepreciationOther Business Interest tax Income taxable Real gainsInvestment deductible taxableOther consumption No Interest No Tax No taxReliefPersonal equity No Interest No Tax No Taxplans reliefPensions No Interest Advantage from Not applicablerelief contributionrelief and tax-free lump sumsShares No Interest Dividends taxed Real gainsrelief taxableBuilding society No interest Nominal return Not applicableand bank accounts relief TaxedSource: Hills (1991)In Britain, owner-occupiers were treated originally in a way similar toprivate landlords. The return on their investment, the imputed rent was taxed,after deduction of expenses, including interest payments and maintenancecosts. Over the years the tax system changed, resulting in improving the taxposition of owner-occupiers. Their imputed rents and capital gains are nottaxed, and they also receive tax relief on the first 30,000 pounds of theirmortgage. Private landlords cannot deduct depreciation or imputed expenses,nor set off losses on property income against income from other sources for104Maclennan and Gibb, (1993) p 12.89tax purposes- thus having a disadvantage over other businesses, as well asowner-occupiers. Housing is largely free from VAT, although it is charged onspending by owners and landlords on improvements and repairs. Stamp duty ischarged at 1 per cent of any transaction of 30,000 pounds or more.Table 6.3: TAX SUBSIDIES TO OWNER-OCCUPIERS IN UK (Pounds)Mortgage Imputed rental Real CapitalGross Annual Income Band Interest Tax Income Tax105 Gains TaxRelief600 191 417 34552600-5199 126 291 26455200-7799 284 306 29377800-10399 300 291 249910400-12999 405 290 288813000-15599 440 308 307815600-20799 488 375 345620800-25999 748 605 469926000-31199 888 619 554531200> 1002 608 4330Source: Maclennan and Gibb (1993) p 20.In Britain, home-owners receive several tax subsidies in the form ofMITR- Mortgage Interest Tax Relief; and non-taxability of imputed rents andcapital gains. MITR rises steadily with income. The subsidy associated withimputed rents is governed by the length of residency and outstanding mortgagedebt, therefore its pattern is less clear with respect to income. The absenceof a capital gains tax, benefits higher house price areas and does not have aparticularly strong relationship with current incomes. Overall, tax subsidiesfail to provide a progressive distribution of subsidy, they are inefficientand sometimes arbitrary and in no way can be said to confirm to rational105imputed rental income tax is the tax that would be levied on the net equity owned by thehousehold, it is net of debt which receives MITR. The exemption from real capital gains taxrefers to the taxable gain made after allowing for inflation, a pound 5000 allowance and assumingsale in 1988 and original purchase in 1982.90housing policy objectives106. Table 6.3 shows the regressive nature of taxsubsidies received by owner-occupiers.The level of owner occupation in Britain has increased rapidly in thelast 40 years rising from 3 million dwellings (31 % of households) in 1951 to15.4 million dwellings (67% of households) in 1991. Since 1970, there has beenrapid house price inflation with national average house prices rising frompounds 5,000 to 60,000- an increase of 1,100 per cent. These two trends,expansion of home ownership and rapid house price inflation, have led to majorchanges in the role of owner occupation in personal wealth holdings. The valueof dwellings as a proportion of all net personal wealth increased from 18% in1960 to 37% in 1975 and 52% in 1989107.Value-added-tax (VAT) is a method of taxing final consumer spending inthe domestic economy. It is a multi-stage tax that falls on all final consumergoods and services, except those that are explicitly exempted. New building isexempt from VAT, presumably on the grounds that housing, like other exempt orzero-rated items, is a necessity.The tax and subsidy system in Britain discriminate markedly betweenhousing tenures. The owner occupier mortgagor receives 25% tax relief oninterest payments on the first 30,000 pounds of their mortgage. As an assetholder, they are exempt from capital gains and income tax. As a consumer,owner occupiers do not pay VAT. Low income owner occupiers, borrowers andoutright owners, have no recourse to income-related housing benefit which isrestricted to tenants. Mortgagors who qualify for income support can, however,106 Maclennan and Gibb, (1993)107Hamnett and Williams, (1993) p 137.91get help with their interest payments. Tenants on low income are eligible forhousing benefit, although this is restricted in the private rented sectorwhere a rent officer can determine whether the rent is reasonable andtherefore eligible for benefit expenditure. Social sector tenants may alsoreceive some sort of price subsidy through mediation from central governmentand also implicitly through historic cost accounting and rent pooling.Evidence suggests that formal subsidy to owners, outweighs that receivedby tenants at relatively low household incomes (5000 pounds per annum) andthat HTE5 are regressive, e.g. the top third of owners receive 2/3rds ofM1TR108. Further, HTEs, in the face of inelastic housing supply, are probablycapitalized into higher house prices with implications for the cyclical natureof the housing market.9’h1 4. Ma-h, P’rn-mq rf T’innni1 iihi+v by Tpniir ii, TTICLocal Authority Private Rented HousingOwner occupation AssociationMortgage Tax Housing Revenue Housing Benefit HousingRelief at source Association Grant(MIRAS)Account Subsidy Improvement Housing BenefitNon-taxation of Grants toImputed rent and LandlordsCapital GainsHousing BenefitImprovement BusinessGrants ExpansionScheme TaxCouncil HousesBenefitsSales DiscountsSource: Willis and Cameron (1993) p 54.Willis and Cameron (1990) show that while the amounts of housing benefitand Housing Rent Assistance (HRA) decrease with rising income bands (no108 Hamnett and Williams, (1993)92housing benefit for people having income over 13,000 pounds p.a., and no HRAfor incomes above 10,400 pounds p.a.); MITR increases with income, with thelargest increase happening when income moves from pounds 20,800-26,000 incomeband to pounds 26,000-31,200 income band. Means tested housing benefit isstrongly progressive, going mostly to renters in the lowest income groups,while MITR is strongly regressive, giving the most benefits to those in thehighest income groups. In between, the lower to average income bands haveaverage benefits from financial subsidies which are substantially lower thanthose at upper and lower extremes on the income groups.The Business Expansion Scheme (BES) was set up in 1983 to assist new109 . . .businesses in raising capital . Individual investors get income tax reliefin the year they buy shares of companies raising funds under the BES. If ashareholder retains the shares for at least five years, no capital gains taxis paid on chargeable gains realized by any subsequent sale of the shares. In1988, the benefits under the BES were given to assured tenancies also. It isestimated that during the first 2 years, 544 million pounds were raised andalmost 10,000 properties would be acquired from these funds. In its first twoyears BES stimulated a supply of new and higher standard rented housing inlocations where private renting was not usually found and which had been letto a wide range of tenants. Just over one half of BES tenants said they foundit easy to afford the rent. The BES has resulted in an additional supply ofprivate rental housing that would not otherwise have been created. Companydirectors said they could not have raised money for private renting withoutthis or some other subsidy.109 This discussion is based on crook and Kemp (1993), p67-85.93Preliminary evidence suggests that the long term impact of BES is likelyto be negligible. Most companies did not think they had a long term future,and perhaps would ultimately sell their properties into owner occupation andwind up the company. Few of them thought that they could raise funds withoutsubsidy under the current housing finance system because rents did not give acompetitive return. The returns from rents were insufficient to attract longterm finance. In the view of the company directors tax breaks or some othersubsidy are needed to make returns from rental housing attractive.Table 6.5 summarizes and compares the housing subsidies taxation andbenefits 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-OCCUPIERSPRIVATE RENTED SECTORTaxation of landlords: Taxation:-rents taxable -Imputed rents not taxed-Interest deductible -Tax relief on first 30,000 ofmortgage (MITR)-Capital gains taxed -No Capital Gains Tax-No depreciation allowance-New Business expansion Schemeconcessions-Stamp Duty charged -Stamp Duty chargedRent RegulationInsulation grantsImprovement Grants Improvement grantsHousing benefit for tenants’ rents Income support payment of mortgage(rent rebate! allowances) interestRates net of housing benefit Rates net of housing benefitExemption from VAT (except for Exemption from VAT (except forrepairs and improvements) repairs and improvements)Source: Hills, Berthoud and Kemp (1989) p 2.6.3 CANADAIn Canada, housing is the most costly item in most people’s budget. Iffurnishings and household expenses such as heat and property taxes are94included, it absorbs, on average, almost 25 of household income110. Forhomeowners, the dwelling generally is the household’s largest capital asset.The various forms of housing assistance available in Canada are listedin 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 $ 8billion1. Almost 80 per cent of federal housing expenditure is in the formof tax expenditures.Table: 6.6 Ma-ior Federal Expenditures for Housing in Canada. 1979.Type of Expenditure Subtotal* Total*CMHC grants, contributions & subsidies: 840social housing (public housing, non-profit 288housing, cooperative housing etc.)market housing (AHOP, ARP, interest 52forgiveness)land assembly & municipal infrastructure 130community relations 133other 237Implicit interest subsidies on outstanding 100loansImplicit subsidies in NHA** insurance fees 15Federal Tax expenditures: 6360non-taxation of imputed net rent 3,700non-taxation of capital gains 2,500RHOSPs 115MURBs 45Rent control costs 225Total non-capital items 7540CMHC commitments for loans and investments 350Total federal housing assistance expenditures 7890Source: Smith (1981) p 455.* $ millions** National Housing ActThe affordability of accommodation and profitability of the housingsector have been a major preoccupation of governments in most OECD countries.In Canada, as in the USA, reliance on private sector housing is greater than110Statistics Canada, (1989), as reported in Harris (1991)111Smith, (1981) p 455.95in most countries of Europe. Similarly home ownership is ideologicallyespoused more than rental housing112. During the recession in 1973-1985,social housing expenditures were controlled but, restraint in directexpenditures was offset by HTEs for private-sector housing. One reason for thedifference in treatment was the necessity to offset the rising problem ofaffordability for the middle classes in the context of recessionary113pressuresSocial housing subsidies (nonprofit and cooperative) usually involvedirect subsidies and loans. In addition to these, home ownership and privaterental housing are subsidized through tax expenditures, such as the RegisteredHome Ownership Saving Plan (RHOSP) and the Multiple Unit Residential Building(MURB) program. MURB mainly helped developers and investors. Direct subsidyprograms, such as the Assisted Home Ownership Program (ABOP) and the AssistedRental Program (ARP) accounted for a smaller portion of these expenditures.For the ownership sector, AHOP was expanded and RHOSP was introduced “toassist young people in accumulating the capital required for a down payment ona house” and as a means for providing “an important new source of mortgagefunds to finance the construction of new housing we require”. For the privaterental sector the ARP was initiated and the MURB tax provision introduced,creating a tax shelter for wealthy investors by permitting capital allowanceson new rental projects to be written off against other income114.By maintaining RHOSP and MURB, future middle-class home owners and112 Lithwick, (1985)113Hulchanski and Drover, (1987) p 53.114 Hulchanski and Drover, (1987) p 58.96wealthy individuals in the top tax bracket retained the subsidies on theirhousing investments in spite of restraint. RHOSP helped address the high costof becoming a home owner and MURB addressed the lack of profitability in the115private rental sector . Tax expenditures in general, and HTEs in particularmainly benefit the higher-income households. The greater one’s income, thegreater is the HTE benefit received. HTEs are not only regressive, but arealso many times greater than direct spending programs on housing (Table 6.6).In most other budgetary categories, the relationship between the two types ofspending is just the opposite: tax expenditures are less, between 30-50 percent of the direct expenditures. As more was spent on HTEs, which benefittedhigher income groups more, it is inevitable that more federal housingassistance was received by the persons earning higher income. As tables 6.7,6.8 and 6.9 depict, this pattern of expenditure resulted in higher homeownership rates for persons in the higher income quintiles, while persons inthe lower income quintiles shifted towards rental housing.m1-,1: 6.7 P(R1 T Tv ir4-11rQq in Crt4 1q79-“--.-- --—-. -.—Income Group Average HTE benefit per tax filerUnder $5,000 $325,000-10,000 17110,000-15,000 31415,000-20,000 61920,000-25,000 96425,000-30,000 131230,000-50,000 199450,000-100,000 3670$100,000 and over 6753Source: Hulchanski and Drover (1987) p 64.115Hulchanski and Drover, (1987) p 62.97Table: 6.8 Changes in Home-ownership Rates in CanadaPercentage of households owning their houseIncome Quintile 1967 1973 1977 1981 Change1967-81Lowest Quintile 62.0 50.0 47.4 43.0 -19.0Second Quintile 55.5 53.6 53.3 52.4-3.1Middle Quintile 58.6 57.5 63.2 62.7 +4.1Fourth Quintile 64.2 69.8 73.2 75.0 +10.8Highest Quintile 73.4 81.2 82.3 83.5 +10.1TOTAL 62.7 62.4 63.9 63.3 +0.6Source: Hulchanski and Drover (1987) p 65.Table: 6.9 Changes in Renter Households in Canada.of households rentingIncome Quintile 1967 1973 1977 1981 Change1967- 81Lowest Quintile 20.4 26.6 29.1 31.1 +10.7Second Quintile 23.9 24.7 25.9 26.0 +2.1Middle Quintile 22.2 22.6 20.4 20.3 -1.9Fourth Quintile 19.2 16.1 14.8 13.6 -5.6Highest Quintile 14.3 10.0 9.8 9.0 -5.3Source: Hulchanski and Drover (1987) p 67.In recent years, tax subsidies to owner-occupiers have far out-weighedthe moneys spent on “social housing”. The immediate effects are sociallyregressive: owners are generally more affluent than tenants, while the mostaffluent, living in the largest homes, have received the greatest subsidies ofall. Thus, the poor are in effect subsidizing the rich. The larger effect ofpromoting home-ownership has been to bolster the developing economy byboosting the demand for goods and credit.In Canada policy providing deep, sustained subsidies to small numbershas been chosen over modest subsidies spread over a larger number of people.This choice has left a large number of low-income Canadians with serious98116affordability problems6.4 United States of AmericaEven though the concept of tax expenditures was developed relativelyrecently, in USA, the tax code has been used to subsidize particularactivities since the first income tax law enacted after adoption of the 16thamendment to the Constitution. In 1913, deductions for mortgage interest andstate and local taxes on homes owned by taxpayers, as well as deductions forsome non business state and local taxes, were allowed117. Governmentintervention to strengthen the supply of housing credit in the US dates fromthe Depression. Thrifts were legally required to invest in housing loans; ifthey devoted 80 of their business to this, they received tax exemptions118.Thh1 1O Ma-ior by Thx in TTA• 19fl— -— flS__LVLL_L-— — —Activity Billion $ of total1. Retirement 87.0 27.92. Home ownershipmortgage interest 25.4Property taxes 8.1Capital gains treatment 13.7Subtotal 47.2 15.13. Health and health insurance 44.4 14.24. Municipal Bond interest 20.7 6.65. Investments 18.4 5.96. State and Local Taxes 19.2 6.17. Charitable contributions 10.5 3.48. Capital gains at death 5.4 1.79. Other Activities 59.5 19.1Total: all Tax Expenditures 312.3 100.0Source: Peterson (1991) p 61.116Lithwick, (1985) p 53.117Peterson, (1991) p 61.118 Iarn and Wolman, (1992) p 102.99Table 6.10 shows that among the activities subsidized by taxexpenditures, housing gets the second largest subsidy. The details of housingtax expenditures for individuals are given in Table 6.11.Th1 - 1 1 Wciii na xrndi t-iir frr TricIi ri ii1 In rT ($ millions)1983 1984 1985 1986 1987 1988Deductibility of 25065 27945 30130 32785 35305 37,950mortgage interest onowner - occupiedhousesDeductibility of 8765 9535 10480 11710 13215 14980property tax onowner-occupiedhousesExclusion of 450 485 475 445 415 385interest on stateand local governmenthousing bonds forowner- occupiedhousingExclusion of 285 355 430 510 585 665interest on stateand local governmentbonds for rentalhousingDeferral of capital 3770 4895 5625 6000 6480 7030gains on home salesExclusion of capital 1255 1630 1875 2000 2160 2345gains on home salesfor persons age 55and overSource: Modified from Surrey and McDaniel (1985) p.p. 7-14.A comparison of tax expenditures and income transfers shows that in thefiscal year 1989, overall transfers (that is direct expenditures) were 2.5times greater than tax expenditures. However, housing and commerce are amongthe few activities, where tax expenditures were many times larger thantransfer spending. The dollar value of tax expenditures for housing andcommerce is 103.7 billions C that is 35.4% of tax expenditures), as comparedto transfer spending of only $20.8 billion (representing a mere 2.8% of100transfer spending)119. This signifies that housing and commerce are subsidizedprimarily through the tax system- exclusions and deductions from income plustax credits, rather than by direct outlays.Table 6.12 Th t-hi-ii of Tax -‘es in USA: 1990Percentage Real EstateINCOME CLASS distribution of Deduction (inreturns (1981) million dollars)Less than $10,000 36.7% 3$lO,000-20,000 26.1% 87$20,000-30,000 18.4% 358$30,000-40,000 14.5%* 670$40,000-50,000 645$50,000-75,000 3.6%** 2,264$75,000-l00,000 1,210$l00,000-200,000 0.6% 1,884Over $200,000 0.1% 1,208TOTAL 100.0% 8,329Source: Peterson (1991) p.p. 86 and 88.* returns filed by income class 30,000-50,000** returns filed by incomes class 50,000-100,000The data in Table 6.12 indicates that the distribution of taxexpenditures by income class is heavily weighted towards persons and familiesin the upper ranges of the income scale. The proposal to eliminate taxexpenditures pertaining to deductibility of interest on home mortgage duringthe debate and discussion leading upto the Tax Reform act of 1986, was metwith such a large protest that the idea was dropped. The value of this HTE in1988 was $27.7 billion, which was equal to 10.7% of the total tax expenditureof that year. Persons and families with incomes of over $100,000 (2% of thetotal return filers) got 22.1% of this benefit. On the other hand, familiesand persons with incomes below 30,000 (70.5% of the return filers) got only10.1% of the total benefit. The paradox of providing subsidy through taxexpenditures is brought out in this quotation from Peterson (1991):119Peterson, (1991) p 72.101“The purpose of the home ownership interest deduction is to encouragehome ownership by mericans, but doing this through the tax expenditure routeresults in large subsidies to a relatively small segment of the population. Iflegislation were proposed in the Congress saying, in effect, that the nationwill provide quite small direct subsidies to encourage home ownership to theroughly 70 of the population with incomes below $30,000, and that thesesubsidies would increase rapidly as family income increases above this level,would such legislation pass? The question answers itself, yet this is the waythe majority of tax expenditures work”.6.5 Developing CountriesVery few studies have been done in developing countries of taxexpenditures. The studies relating to the effect of tax expenditures onhousing are even fewer.Urban housing shortages are exacerbated by rapid population growth andhigh rates of urbanization in developing countries. Lower gross domesticproducts of these countries preclude large-scale subsidization of housing bythe governments. While the problem of housing shortage is deeply rooted in thesocio-economic circumstances of developing countries, housing itself plays asignificant role in their economic development. Government housing policy andhousing planning are critical factors in determining the socio-economiceffectiveness of housing. It is paradoxical that even though governments indeveloping countries extensively use tax expenditures to steer investment incertain sectors, there is hardly any analysis or evaluation of their120effectThe Indonesian fiscal system was replete with tax incentives prior to1984121. Most of these were discontinued as evidence indicated that few if anyof the incentives yielded the desired results. They caused “massive120MaktOUf and Surrey (1990) p 204.121Gi11iS (1990) p 89.102hemorrhages from the treasury” and when effective had a bias towards capitalintensity, as large investments received longer tax holidays. They also oftencreated intractable problems in tax administration, as they required highertax rates on taxpayers not benefitting from them; and discriminated againstsmaller firms who lack the resources and the influence to file for and receiveincentives.Hong Kong and Singapore are among the few developing countries whichhave achieved success in public housing policies and programs122. In thepursuit of development through rapid industrialization, many developingcountries ignored investments in large scale public housing projects, as theproductivity of housing investments was considered too low to be economicallyefficient. While most developing countries were reluctant to allocate funds tohousing, Hong Kong and Singapore began large scale low-income public housingprograms. They viewed housing as an integrated part of development and123achieved success in both housing and economic growthPublic housing programs in both Hong Kong and Singapore are consideredto be essential components of the political strategies for economic and socialdevelopment124. Both these countries have complex and well-administeredsystems for public housing, consisting of a statutory body which isresponsible for all aspects of public housing including planning, finance,design, construction, allocation and management. This administrative body hasa structured organization, and each component has clearly defined122Shen, (1986)123Shen (1986) p 38.124Shen, (1986) p 39.103responsibilities.The public housing program in Hong Kong began in 1954, after a fire inDecember 1953 destroyed homes of 58,000 persons in Shek Kip Mei, a squattersettlement in Kowloon. The Hong Kong government constructed emergencyaccommodation125.Rents lower than those paid earlier by the occupants fortheir huts were charged for these units. Till 1972, the low-income publichousing programs were mostly financed directly through government revenue orthrough low-interest loans provided by the government. These programs receivedgovernment subsidies and were allotted land at less than market value126.Since 1973, public housing in Hong Kong has been administered by a singleorganization- The Hong Kong National Housing Authority. Its activities arefinanced primarily through government revenue and through rents received bythe authority. After 1976, land for low income housing was provided free bythe government.In Singapore, the Singapore Improvement Trust- a government organizationin charge of building public housing, has been in existence since 1927, longbefore the establishment of the Housing Development Board (HDB) in 1960. Thesetting up of HOB, a statutory body, marked the beginning of the constructionof large scale public housing programs dominating the housing sectors ofSingapore. Capital for the construction of public housing was provided byloans from the government to the HDB127.The use of Central Provident Fund (CPF) savings for the purchase of125Shen, (1986) p 32.L2EShen, (1986)1278hen, (1986) p 34.104public 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 wasincreased from 10% in 1955 to 50% in 1984. Under the CPF housing financescheme, members could withdraw upto 80% of their total CPF savings forhousing128. Almost the entire reserve of CPF savings has been invested ingovernment securities. A major portion has been used to provide substantialfunds to enable home buyers to meet their initial and mortgage payments, andto finance public housing programs.It is interesting to note that both Hong Kong and Singapore achievedsuccess in tackling housing problems, not through tax expenditures, but mainlythrough land reforms, and through public housing programs financed by thegovernment. In Singapore, investment in CPF was made compulsory, and notattracted through fiscal incentives (unlike most countries) . However, thecircumstances of Hong Kong and Singapore are unique, as they have fullemployment and tightly controlled migration policies. Both the countries haveutilized savings to finance the public housing programs. In Singapore,compulsory savings in the CPF are akin to a tax on salary, whereby both theemployer and employee each deposit 25.3% of the salary in the fund. It isdifficult to transplant similar policies with comparable success to India, dueto 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 waysin which HTEs effect housing are discussed in the next chapter.128Goh, (1988) p 155.105CHAPTER SEVENEffects of Housing tax Expenditures on HousingThe effects of housing tax expenditures on housing, housing finance andthe national economy are described in this chapter. The relevance of theseeffects for India, is discussed at the end of each section.7.1 Growth in Home-ownershipThe national impact of housing tax expenditures is reflected in thenature of urban housing markets. Table 7.1 depicts the post- war trend in therate of home-ownership in selected OECD countries and India. With theexception of Canada, all countries experienced a significant increase in therate of home-ownership in the early post-war years. As HTEs lower the cost ofowner-occupied housing, it is reasonable to argue that favourable taxtreatment will enable a greater expansion in owner-occupation than wouldotherwise be the case. Even if the price elasticity of housing is zero, thisexpansion can come about through tenure transfers.Table 7.1: Home Ownershio in India and Selected OECD Countries. 1950 1960 1970 1980 1986Countries1-INDIA 46.27% 47.12% 53.61%AUSTRALIA’30 45% 71% 67% 68% 69%(’88)CANADA 65.6% 66% 60% 64.3% 63% (‘87)DENMARK N/A 45.7% 48.6% 52% 66%FINLAND 55.9% 60.8% 60.4% 64% N/AFRANCE 35.5% 41.6% 44.7% 47% 51%(’84)NORWAY N/A 52.8% 52.6% N/A 67%SWEDEN N/A 36.2% 35.2% 39%(’75) 55%UNITED KINGDOM N/A 41.8% 49.2% 52% 64% ( ‘ 87)UNITED STATES 55% 61.9% 62.9% 65.6% 63.8%(’88)Source: Wood (1990) and National Institute of Urban Affairs (1989)129Refer to urban areas only, and in the census years, i.e. 1961, 1971 and 1981.130Figures for Australia refer to the nearest census year.106It is difficult to gauge precisely the effect of HTE5, as the trend inhome-ownership rates in their absence cannot be observed. However empiricalstudies of the tenure choice decisions indicate that in US the removal offavourable tax provisions would lead to a fall of 4.4k in the incidence ofowner-occupation131.It is also estimated that after allowing deductions forall operating costs, the long-term effect of taxing imputed income would be a6.5 reduction in owner occupied households.In the US, encouragement to the private sector has been eroded throughtax changes. The remaining subsidies, notably through tax-exempt bonds, havebeen limited, and they are too shallow on their own to prompt investors tobuild for the group most in need, namely low-income households. The result hasbeen a marked drop in the production of property for lower-income and evenmoderate income groups, either for renting or home-ownership.It has been estimated that between 1963 and 1979, the number of homeowners in US was nearly 50 per cent more than it would have been without thefinancial incentives to home-ownership. In both US and UK the most powerfulstimulus has been the preferential tax treatment of homeowners132.In Britain the tax incentives to home-owners apply equally to resold andnew housing and probably have more effect in raising the prices of existinghousing (by increasing demand from persons wanting to avail tax incentives)than in encouraging production.Developing countries have high rates of owner-occupation, despite lowper capita income, primarily because owner-occupation is higher in rural131wood, (1990)132Karn and Wolman, (1992) p 121.107areas, and there is less urbanization133.The urban areas have lower rates ofowner-occupation. In India also, owner-occupation is higher in rural areas.Home-ownership in urban areas has been growing, but there is no empiricalstudy linking this growth to the use of tax expenditures.7.2. Urban SprawlA feature of the growth in home-ownership has been its development onthe outskirts of metropolitan areas, and the emergence of suburbanisation andurban sprawl. Factors such as advances in transportation technology,employment change, and fall in energy costs have played a role in thedecentralization process during 1960s and early 1970s. However HTEs are also afactor as there is evidence that they have aided the demand for larger singlefamily units in the suburbs of metropolitan areas134. This has led to otherfiscal problems for the government, as expansion of the urban area requiresheavy public capital expenditure in infrastructure, while out-migration erodesthe economic and fiscal base of the central city. This leads to highermunicipal taxes in the central city, and can reinforce the suburbanisationprocess as households move out to avoid high taxes. As labour market locationconstraints are less binding on higher income households, inner city areas mayhave an increasing proportion of households with low incomes. These lowincomes can preclude maintenance and improvement of the housing stock vacated133Asher, (1989). As per World Development Report, 1992, Urban population accounted for only38% of total population of low income countries (p.278).134wood (1986)108by high income groups135. Spatial concentrations of poor quality housing aresymptomatic of the problem.Indian cities have been growing, both in numbers and area. This growthin urban sprawl, appears to be more due to increase in urban population136,rather than because of HTEs.7.3 Distributional Impacts and Tenure choiceIt is widely believed that the tax system favors owner-occupied housing;because the services of owner-occupied housing are untaxed while rentalpayments are treated as taxable income. Even though landlords are permittedtax deductions not available to homeowners, as long as there is some positivetax on rental income, owner occupied home ownership is said to be tax-favoured.Home ownership has been favoured by the tax code in UK and homeownership and residential investment have been strong in recent years (Table7.2) . Imposition of taxes that discourage home ownership may result insubstantial dead-weight losses given the presence of pre-existingdistortions 137Do tax policies favouring investment in the housing finance promote homeownership at the expense of those preferring or needing to rent, such asmobile 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, and arebeing mainly turned to commercial uses (as warehouses or godowns) or are being occupied by lowincome groups. Developing countries also show higher percentages of owner-occupation in urbanareas, 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 to240 million in 1991.137Gordon et al, (1987)109both in the vast difference in the cost of HTEs in the favour of homeownersand direct subsidy to tenants in the US, and as the figures in Table 7.2 showhome ownership is rising. The distributional effects of the current system ofsubsidies, benefits and taxation in UK show that the value of tax advantagesis low at the bottom of the income distribution, rises slowly for most of theincome range, but rises sharply for the highest income groups138. Thisindicates that taxation policies alone will mainly affect the housingdecisions of the richest.7.2 iih,1 Fvr ‘Pri,i in UK and USA—-—.——1971* 1981* 1983* 1985* 1987*UNITED KINGDOMHome-ownership 49.2 57.1 59.9 62.1 64.1Public-sector rental 31.0 32.7 30.9 29.7* 28.4**Private rental fl9.8 10.1 9.2 8.3 7.5Total rental 50.8 42.9 40.1 37.9 35.9UNITED STATESHome-ownership 62.9 65.3 64.7 63.5 64.0Public-sector rental n/a 2.4 2.6 2.7 2.5Private rental n/a 32.3 32.7 33.8 33.5Total rental 37.1 34.7 35.3 36.5 36.0Source: Karn and Wolman (1992) p 43.*As % of total householdsIn US the federal tax expenditure in 1987 for housing amounted to $55.4billion or 1.2% of the GNP. In Britain estimated tax expenditures for housingamounted to pounds 5.1 billion or 1.8% of GNP in 1982, including slightly morethan 2 billion for mortgage interest tax relief and 2.8 billion for capitalgains exemption. All this goes to the owner-occupied market, whereas in US, asubstantial amount goes to the private rental sector139.Both the US and the UK employ a variety of tax incentives to stimulate138Hi11S (1991)139icarn and Wolman, (1992) p 78.110demand in the housing sector. These devices ultimately encourage supply. Theyalso encourage expansion of housing demand. In both countries home-owners maydeduct mortgage interest costs from their taxable income, thus reducingincome-tax liability by the amount of the deduction multiplied by thetaxpayers’ marginal tax rate. This in effect lowers the cost of home ownershipto the home-owners and increases housing demand, investment and production. InBritain, since 1988, loans for improvement of the property no longer qualifyfor tax deduction. In the US the deduction is unlimited and applies toimprovement loans and to vacation and second homes also.In both US and UK, the preferential tax treatment given to home-ownershas been criticized as an ineffective mechanism for increasing production andinvestment in housing. It encourages home owners to consume more housing, butas the relief applies to both existing and new housing, the additional housingconsumed is not necessarily new. The ending of relief on home improvements isseen as being counter-productive, and leads to poor maintenance ofexisting housing. The equity and efficiency of the system are in doubt,because tax relief gives greatest financial assistance to those who would bemost likely to be able to purchase without assistance and so does little toincrease access to home-ownership for marginal buyers. The system leads toover-consumption of owner-occupied housing, which distorts the housing market,is wasteful of resources, and may even draw investment away from other sectorsof the economy’40.Tenure-neutral tax reforms would subject owner-occupiers and privatelandlords to the same tax provisions relevant to the investment good status of140Karn and Wolman, (1992) pp 94-95.111housing. In competitive market conditions, these changes would significantlylimit allocative distortions. These reforms, if aimed at providing housingwithin the means of lower income groups; would increase the cost of housingfor middle and higher income groups who are existing home-owners. The largerthe fraction of a country’s housing stock which is owner occupied, the morepolitically unattractive these measures become.In India, there is no discrimination in the tax treatment of owner-occupiers and landlords, except for exemption of owner-occupied housing fromwealth tax. Thus the HTEs do not affect tenure choice. Any tax incentivesdesigned to encourage owner-occupation, should be carefully formulated to beneutral across income classes, as otherwise they will be regressive and willdiscriminate against low and middle income groups, thereby exacerbating theirhousing problems.7.4 Tax Incentives and Rental PropertyUnfavourable tax treatment, combined with rent control and security oftenancy, account for much of the vast difference between US and UK in theprivate rental housing supply. Between 1973-1987 the private rental stock inUK declined by more than 1.1 million units, while in the US it increased bymore than 8 million units’41.Mortgage interest on rental property is deductible in Britain, butlandlords pay tax on their rental income, while owner-occupiers do not pay anytax on their imputed rent. Landlords are also disadvantaged vis-à-vis otherinvestors, as depreciation on rental property is not deductible, while onother business assets it is. This has the effect of discouraging investment in141 Karn and Wolman, (1992) p 95.112rental units relative to other investments.Several tax incentives are given to the private rental sector in theUSA. Mortgage interest for rental property is deductible as a business cost.“Tax syndication”, a mechanism for producing lower-cost rental housing throughco-operation between profit-making and non-profit making organizations, allowsbusiness partners to classify investment in real estate as a loss to offsettax liabilities resulting from other income. The biggest incentive toproducers of rental housing has been the favourable treatment with regard tothe depreciation of rental property for tax purposes. Limitations ondepreciation allowances in 1979, caused disinvestment and a boom in theconversion of rental apartments into condominiums (group-ownership schemes)142 The effects of tax changes were again demonstrated in 1981, when theshortening to 15 years of the period over which real capital costs could bedepreciated increased the attractiveness of investment housing relative tohome-ownership. This resulted in the rapid expansion of capital flow intoreal-estate syndicates for investment in income-producing property (primarilycommercial but also residential). The Tax Reform Act of 1986 reduced the taxsubsidy to landlords very substantially by reducing the favourabledepreciation provisions, by putting an end to tax syndication; and through thetaxation of all capital gains (including residential) at the same rates as143ordinary incomeIn India there are no HTEs designed specifically to encourage productionof housing for the private rental sector, though the same is not discriminated142Karn and Woman, (1992) pp 97-98.143 Karn and Wolman, (1992).113fiscally vis-â-vis the owner-occupied sector. The constraints to the privaterental sector are provided chiefly through the Rent Control laws, whichregulate the amount of rent chargeable and also restrict the rights of thelandlord in terminating the rental contract, and raising the rent. Theseprovisions have led to serious problems in the supply of rental housing. Rentsfixed at below economically viable levels144 result in poor maintenance of therental property. The perceived difficulties in getting rental premises vacatedresult in higher deposits being demanded. In big cities, people prefer to keeptheir properties vacant rather than letting them out. It is estimated thatremoval of rent control laws would bring such properties on the market, andaid in addressing the housing shortage145.7.4.2 Policies for Financing Private Rented PropertyMany countries have been experiencing a rise in the relative price ofhousing in both the owner-occupied and rental sectors146. The increasing priceof housing services leads to high rent-to-income ratios, particularly for thepoor. The affordability issue is perceived to be an important policy problem,and is the prime motivator of much of the intervention in private rentalhousing markets. A common way to deal with the affordability problem has beento enact rent controls. Although there is no evidence that controls solve theaffordability problem in the private rental market of any country, there isevidence that the existence of rent controls leads to various other144This is particularly evident in the inner city areas of metropolitan cities, such asDelhi, Bombay and Calcutta, where rents fixed in l940s (at the rate of Rs. 10-20 per month)continue to be charged for prime residential property.145India Today (1993).146 Gyourko, (1990).114interventions, many of which are economically wasteful, in order to helpgenerate increased stock in depressed rent-controlled private rentalsectors147. One such example is the British Government’s Business ExpansionScheme which involves potentially huge tax expenditures to subsidizeinvestment in private rental stock.In addition to direct intervention via controls on rents, many countriesuse direct and indirect subsidies for rental housing producers and/oroccupants. The indirect subsidies usually take the form of tax expenditurestargetted towards the suppliers of rental housing. Most of these are difficultto justify on purely economic grounds, but they often appear to be theconsequence of societal preferences to alter the distribution of resources.However, they appear to benefit the supplier of rental housing more than thetenants.There are direct subsidies to both builders and renters. Most prominentdirect subsidies tend to be in the form of rent allowance schemes to poorerrenters who choose not to live in traditional public housing. This isparticularly prominent in the USA which has a very small public housingsector. Many other countries have similar programs, and these direct subsidiestend to be income subsidies. The actual formulae used differ widely acrosscountries leading to large differences in renter household coverage acrosscountries. Direct subsidy for builders may or may not be linked to newproduction. The result of direct subsidy is to allow access to reasonablequality housing for poorer households.Direct subsidy programs are linked with national budget conditions.147Gyourko, (1990).115Overall direct subsidy amounts appear to vary with the degree of fiscal crisisin the country, as housing budgets are among the first to be cut when a fiscalcrisis occurs. However fiscal crises do not squeeze tax expenditures soseverely. Tax expenditures are the most important form of indirect subsidy tothe private rental sector. The legal incidence of tax expenditures in thissector is on property owners. Laws do not allow tenants to write-off housingexpenses against income solely because they are tenants. The true economicincidence of the tax expenditures is not clear.USA has most assiduously followed the tax expenditure strategy withprivate rental stock owners. 1981 tax code revision allowed high levels ofaccelerated depreciation (15 year economic lives for rental properties) andmade it easy to use paper losses to offset other income. Consequently manyprojects that were true losers economically were turned into large positivenet present value deals. Revision of the tax code in 1986 removed most of thetax expenditures148.There is evidence that investors did respond to the subsidies as largefluctuations occurred in the production of new multi-family units around thetime of the tax code changes. However, there is no evidence that the taxexpenditure programs have done anything to solve the affordability problem ofpoorer households. In the US, these programs appear to have led to someincreased investment in middle and upper income rental housing with thesubsidy benefits being split between the owners and occupants of that149stock148 Gyourko, (1990).149 Gyourko, (1990).116In an attempt to attract capital into its small and weak private rentalsector, UK enacted a major tax expenditure program through its BusinessExpansion Scheme (BES) - which allows a tax write-off to investors who buyshares in a new company that provides new private rental units. There is notaxed capital gain if there is no sale for 5 years150. There is evidence thatthis plan is attracting capital to the private rental sector151. There is apossibility that the new rental units will not remain in the rental sector, asthe highest bidder for these properties may convert them to owner-occupiedstatus.The US and British tax expenditures are not typical to other countries’programs. Tax expenditures are off-budget and effectively hide the real costof the economic distortion from the public. The truly large tax expendituresare targetted towards the owner-occupied sector, and the tax expenditures forprivate rental housing are dwarfed by them.In Australia, attempts made in 1985 to restrict tax expenditurespertaining to residential rental sector had to be partly reversed in 1987.This shows that rental income alone was not enough to make investment in thissector attractive. However, Badcock et al (1991) say that the effects of thechanges to taxation policy in 1985 and 1987 were amplified by other exogenousfactors, such as the sharp rise in interest rates, the cyclical slowing ofhousing investment, and the resurgence of the stock market in October, 1987.150Many BES companies have announced that they will not pay dividends for 5 years. At theend of that period (when they will not be liable for capital gains tax), they plan to sell theproperties and then distribute the proceeds to shareholders. This indicates that the investmentin private rental sector, is motivated by the desire to reduce tax liability, by using the taxincentives for BES companies.151Gyourko, (1990).117These events worked in tandem with the shifts in taxation policy, so as toconfirm both Treasury officials and industry lobbyists in their impressionthat the restricting of negative gearing and the taxing of capital gains wereprincipally responsible for the temporary shortage of rental accommodationexperienced in Sydney. As the government continues to use tax incentives as aninstrument of housing policy, expansion of supply of affordable private rentalaccommodation is dictated by the structure of opportunity costs to theinvestors, rather than responding directly to needs of the tenants.In India, residential property is generally not built exclusively forprivate renting. Apart from rental housing provided by employers, most low-and middle-income tenants rent a portion of housing, that is otherwise owneroccupied. HTEs directed to encourage investment in private rental sector canbe useful only if the constraints placed by other policies such as rentcontrol laws are simultaneously addressed.7.5 Housing Credit InstitutionsIn Britain, governments have given building societies considerableindirect support through the tax system. For many years investors in buildingsocieties have had their interest taxed at a lower rate than income from otherinvestments. As a consequence, more savings are channelled into housing creditinstitutions than would otherwise have occurred152. In 1981, banks entered themortgage market, and were extended some of the tax advantages for depositorsavailable to building societies.In India, preferential tax treatment of housing credit institutions isstill comparatively recent (1988) and there are no empirical studies regarding152 Karn and Wolman, (1992) p 100.118their effect. However, Ahluwalia (1979) has reported that the interestelasticity of private investment exceeded two, which would suggest that a taxpolicy aimed at altering the rate of return could be stimulative153. Similareffect can be expected from the tax incentives favouring housing creditinstitutions.7.6 Tax Relief on BorrowingIn both the US and the UK, the fact that home-owners can deduct mortgageinterest payments from their gross income for income-tax purposes provides asubstantial public policy incentive for households to own rather than renttheir house.Lower income homeowners in both UK and USA receive very little benefitfrom tax relief. This is partly because tax relief applies to those ownerswith mortgages, and lower-income families are less likely to have mortgages,because they are more likely to be elderly people; and if young, they are morelikely to have failed to qualify for a conventional mortgage both because oftheir incomes and the type of older property they often have to buy. Higher-income owners also receive more tax relief as they are subject to highermarginal tax rates. In Britain- the impact of tax relief has been narrowed byallowing it only on the first 30,000 pounds of any loan. In 1988, anotherloophole was closed by restricting the tax relief only to one loan perproperty.In the United States there is no ceiling on the amount that may qualifyfor tax relief, owners may claim relief on more than one property at the sametime, and may claim relief on real estate taxes as well. As a result, theEbrill (1990) p149.119combined effect of mortgage interest and local real-estate tax deductions hasbeen much more dramatically regressive in US than in Britain. Nearly all high-income families have been able to take advantage of these savings, whereasonly a very small proportion of low-income families was able to do so’54.In India, tax relief on borrowing for housing investment is allowed inthe form of deduction of interest. The quantum of relief is restricted and itcan be set off only against income from house property. The relief is paidonly for borrowings from formal financial institutions, thereby covering onlya fraction of the total finance used in the housing sector. bsence of anyprovision for tax credit for non-tax payers also restricts the potentialeffect of the relief. It is also regressive as interest paid is deducted fromtaxable income, resulting in larger tax relief for persons paying highermarginal tax rates.7.7 Promotion of Home-ownership by Lower-income GroupsIn both Britain and US there have been periods when policies have beenparticularly directed at increasing home-ownership among the lower- ormoderate- income groups. In the US this was between the late 1960s and the mid1970s, and in Britain from 1979 onwards. In Britain, the Option MortgageScheme, originally announced in 1966, was designed to bring home-ownershipwithin the reach of lower-income households, notably those whose income wasbelow the basic income-tax threshold and who received no subsidy on theirmortgages. Originally the subsidy involved a government contribution, directlyto the lenders, of 2 per cent of the interest on the outstanding loan ofanyone opting into the scheme. This was still less than the implicit rate of154Karn and Wolman, (1992) p 124.120subsidy given to basic-rate taxpayers through MITR, so in 1970, the scheme wasrevised to allow the subsidy to vary with the tax rate, thus keeping the twosubsidies roughly equivalent. With the basic tax rate of 30%, the optionmortgage thus required the mortgagor to pay only 70% of his mortgage interestpayments, with the government paying the remaining 30% to the lendinginstitution. The importance of option mortgages has varied according to therelationship between the tax threshold and the level of income needed topurchase, if a large number of people with incomes below the tax thresholdwere able to buy, then the take-up of option mortgages was high. The advent in1984 of “Mortgage Interest Relief at source” (MIRAS) which required mortgagorsto pay only the net (post tax) mortgage payment to mortgage-lendinginstitutions, placed all basic-rate taxpaying and non-tax paying homeowners ona similar footing with regard to subsidy, regardless of income and in effecteliminated the separate option mortgage. Until 1990, higher-rate tax payerscontinued to reclaim rebates over and above MIRAS, so they still received alarger subsidy. Other schemes to help low-income home-owners were for the saleof 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 aimed at lower incomegroups for promotion of home ownership. A scheme drawn on the lines of MIRASin UK would be useful, but will benefit only those who are able to availcredit from formal sources. As such credit is scarcely available to the poor,there is a potential danger in such a scheme resulting in more discriminationtowards them. However, tax incentives are provided to businesses andcorporations, for making deposits in funds used to provide housing for thesegroups. Also, private developers and builders have to provide a certain121percentage of the housing they construct to lower income groups, and thisexpense is allowed weighted deduction for tax purposes. Similar weighteddeduction is also allowed to employers for providing housing to their lowerincome employees. The actual incidence of such schemes is not known in theabsence of any empirical study.7.8 How Fiscal Preference Affects Different Income GroupsHills et al(l989) have described how fiscal incentives affect differentincome groups in Britain. Support for owner-occupation reaches the better offbecause it is they who tend to buy houses, and because the benefits arepositively associated with income. In general, support for rental sectorreaches the worse off because they tend to rent (and so receive the benefitsof subsidies such as the means tested housing benefit and Housing RentAssistance) and because rent rebates are inversely related to income. Thisdifference in the incidence of the two types of subsidy produces an X-shapedgraph, clearly showing that the current strategies provide an incentive forrich people to become owner-occupiers (though no incentive is needed) . Butpoor people are forced to remain as tenants- there is no benefit for lowincome owner-occupiers. The current structure of subsidies stands in the wayof the government’s objective of extending owner-occupation to people withbelow average incomes. In comparison with the X-shape of the current system, atenure-neutral scheme would have two identical lines, each horizontal ordownward sloping155. It is important to note this potential discriminatoryeffect of HTEs against low-income owner-occupiers when recommendingformulation of housing tax expenditures.155Hi11s, Berthoud and Kemp, (1989) p 38.122CHAPTER EIGHTCONCLUSIONS JND RECOMMENDATIONSThis chapter concludes the discussion regarding the effect of fiscalpolicy on housing and details specific recommendations to promote urbanhousing in India. The chapter starts with Section 8.1, wherein the limitationsof the study are given. Section 8.2 lists the major conclusions of the study.Implications of these conclusions and recommendations for India are presentedin section 8.3. Section 8.4 suggests areas for future research on thissubject.8.1 Limitations of the StudyBefore presenting the conclusions of the study and making suggestionsregarding fiscal policy measures that influence housing, the limitations ofthis study are reviewed. The study suffers from the constraints placed by thelimited availability of both qualitative and quantitative data. Though thereis a vast literature on the individual topics of both housing finance andfiscal policies, very little appears to have been written on how housingfinance is influenced by fiscal policies. There are some readings on thissubject, but they pertain mostly to the developed countries. This issurprising, as most developing countries use fiscal policy measures to attractresources for investments in certain priority areas, in a bid to bring aboutsocial and economic change. One probable reason for the lack of literature inthis field in developing countries may be that direct taxes form a smallpercentage of national revenues. As the incidence of direct taxation touchesfew people, the behaviour of the majority of the population is not expected tobe influenced by fiscal policy. The effects of these fiscal policies, are alsodifficult to evaluate in isolation, as their provisions are very123complicated156.8.2 ConclusionsThe efficacy of tax incentives has seldom been evaluated, despite theirwidespread use in developing and developed countries157. However, recentlythere have been many empirical studies which suggest that savings andinvestment are quite sensitive to tax-induced changes in the expected rate ofreturn. Most of these studies are focused on the United States. Their mainconclusion is that the aggregate level of saving is not particularly sensitiveto tax-induced changes in the rate of return, although tax factors may alterthe composition of financial savings158. Increasing private savings may not bethe goal for tax policy in a developing country but, it may seek to increasethe share of those savings that flow through organized financial markets.Although there is some evidence that investments in certain forms of financialassets may be responsive to such inducements, it is not clear that thesebenefits are worth the cost incurred in terms of fiscal losses, economic159distortions, and diminished equityAmong governments of developing countries, it is a widespread practiceto operate schemes which give tax concessions. Due to conceptual difficultiesin measurement and the inadequacy of data available, even those countries thathave made most use of fiscal incentives have rarely evaluated them. Thecontradiction between the developing countries’ extensive use of tax156Buckley et al, (1989) p 23.157Bird and Oldman, (1990) p 131.158Bird and Oldman, (1990), p 141.‘59Bird and Oldman (1990) p142.124incentives as a major instrument for achieving government objectives and theabsence of any tax expenditure analysis is striking160.Detailed analysis and evaluation of tax expenditures has been donemainly in developed countries that prepare a tax expenditure budget, such asCanada, the UK and the USA. This is the primary reason for detailedexamination of these countries’ housing tax expenditures in this study. Themain conclusions deduced are:1. Most countries intervene in the housing market to address shortages. Taxpolicy 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 thanthe poor.3. Empirical studies show that tax incentives encourage the growth of home-ownership, especially in the UK and the USA.4. Housing tax expenditures are perceived to be one of the factors responsiblefor causing urban sprawl. It is argued that such tax policies encouragedincreased consumption of housing, thereby causing people to move to sub-urbanareas.5. Housing benefits and tax incentives provided by countries such as UK andUSA tend to favour high-income owner-occupiers and low-income tenants. This isprimarily because tax expenditures for owner-occupiers tend to grow withincome, while benefits provided to tenants taper off with increase in income.6. Tax incentives are useful in directing savings towards formal financialinstitutions including housing finance institutions.160 Maktouf and Surrey (1990) p 204.1257. Tax reliefs for contractual saving schemes for housing encourage publicparticipation. Similarly tax expenditures on borrowings for housing finance,encourage people to avail them.8. Housing tax expenditures usually have only an indirect impact on low incomegroups.The implications of these on urban housing in India are discussed in thenext section.8.3 Policy Implications and Suggestions for IndiaGovernment intervention in the housing sector is essential to promoteinvestment in this area. Taxation is one of the instruments through whichgovernments intervene to direct investment towards priority sectors. Taxpolicies designed to stimulate housing can lead to an increase in the overallsupply of housing, thereby making it accessible to larger sections of thepopulation. It is seen that most countries recognize this, and use fiscalpolicy measures related to housing. Conclusions listed in the precedingsection show that tax policies designed to promote housing may have certainimportant implications, which should be kept in mind while making any policysuggestions regarding taxation policies formulated to increase housingfinance.8.3.1 Regressive incidence of Housing Tax ExpendituresThe regressive incidence of HTE5 of the countries studied are notinherent in their structure. The regressiveness is due to the way these taxexpenditures have been designed and implemented. This problem associated withHTE5 can be addressed through their redesign as has been done to some extentin MIRAS in UK. The real danger with tax expenditures is that, as they are notgenerally subject to open and thorough public scrutiny, it is easy for such126regressiveness to creep in and go unnoticed by the public.If housing tax expenditures favourably impact the richer members of thesociety’61, then the crucial question is how should such policies be used fora developing country like India, where per capita income is very low and asizable section of the population lives below the poverty line. As thepopulation of tax-payers in India is very limited, the effect of fiscal policymeasures directed at them, is restricted in scope and magnitude. A housing taxexpenditure system designed on the lines similar to the HTE5 used in USA or UKwhich explicitly favors rich owner-occupiers would not be suitable for India,as it would exacerbate the housing problems of the poor. A system likeIndonesia, where all tax allowances, including those favouring housing, havebeen abolished, will also not suit India, as then there will be no additionalincentive for anyone to invest in housing. Even the negative impact on owner-occupied housing, will fall partly on the tenants, as most owner-occupiersrent a portion of their dwelling. The current system of HTEs in India does notdiscriminate between the owner-occupiers and the tenants. The potentialregressive effects of HTE5 have also been reduced, by placing limits on thedeductions available, and by providing tax credits at the basic tax rate.8.3.2 Housing Tax Expenditures encourage Home-ownershipThis effect of HTE5 is also not inherent, but is due to the fact thatHTEs have been explicitly designed to encourage home-ownership. This designreflects the political policy of the countries studied, where home-ownership161This is what the experience of the countries studied shows. This regressivity of HTE5 isnot inherent, hut is a result of the way in which they are formulated. However, academically itis possible to design and administer progressive HTEs for the benefit of the poorer sections ofthe society. The continued use of regressive HTE5, is a commentary on the political and socialsetup, that allow such instruments to exist, that favour the rich at the cost of the poor.127has been promoted because it has been considered politically desirable andacceptable to do so. Similar promotion of the cause of landlords who supplyprivate rental housing, may not be accepted equally as a valid political aimas it would be seen as promoting the interest of the landlord, not the tenant.To promote the cause of the tenant, HTE5 designed in the form of deduction orallowance of rent paid, could be used. The fact that none of the countriesstudied use such a tax expenditure, shows that these countries consider home-ownership desirable. However, 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, which is subject to being restrictedin times of fiscal crises. It is not to say that tax expenditures arepermanent, but as Hulchanski and Drover (1987) have shown subsidies are moresusceptible to be pruned in times of fiscal restraint.In India, taxation policies treat both owner-occupiers and landlords ina similar manner, and so do not encourage one at the expense of the other.This manner of treatment is useful, as there is comparatively little privatehousing built expressly for the purpose of renting only. Private rentalhousing is generally in the form of partly let out owner-occupied housing. Ifprivate landlords are allowed to deduct allowances similar to business incomefrom house property income, then that would result in more housing being builtfor renting. However to assist the tenant, there is need for tax allowancesbased on the rent paid by them. To ensure that such tax policies areprogressive, they should be subject to a ceiling limit and should be allowedat the basic tax rate. However, such a policy would not help the poorertenants, who do not pay any taxes, and in the long-term may even affect themadversely, as the tax paying tenants would be ready to pay higher rents,128thereby causing inflationary trends in rents. It is difficult to promote aprogressive private rental housing policy in India, through tax policymeasures only.8.3.3 Housing Tax Expenditures cause Urban SprawlTax expenditures have been shown to cause urban sprawl in QECOcountries. However, in India there is no evidence to this effect.Theoretically HTEs designed to encourage housing, would lead to an increase indemand for housing, and will cause urban sprawl. It is essential to be awareof this potential effect, and take measures to address it, as urban sprawl inIndia would result in expensive and difficult to afford infrastructure costs.8.3.4 Housing Tax Expenditures and Mobilization of SavingsLack of financial resources is a crucial constraint to housing activityfor most individuals in India. At the same time the rate of savings at thehousehold level is significant. There is considerable scope for capturing thepotential savings, including that of the informal sector, through contractualsavings schemes linked to guaranteed loans and access to shelter. Taxincentives designed specifically to stimulate provision of loans by the HFI5to low income groups would be particularly useful, as the informal financesources that these groups depend on are more expensive than formal finance.Similarly tax concessions for deposits with HFIs that provide long-termfinance for housing will also encourage the growth of finance available forhousing.Provident and pension funds should be allowed to invest in companydeposits/bonds of housing finance institutions (HFI5). This would help thecash-strapped industry in mobilizing resources from the household sector.Considering the importance of housing finance in urban growth, it is necessary129that HFIs get incentives similar to those enjoyed by the Unit Trust OfIndia162. HFIs should also be exempted from interest tax as the borrowers ofhousing loans are generally in the low and middle income groups, and this willlower their cost of borrowing. In addition to granting exemption to assesseesfrom capital gains tax on purchase/construction of a residential house, theoption of investing the capital gains in approved bonds/deposits schemes ofHFIs should also be given. Since HFI5 give long-term loans and are thus atgreater risk, they should be allowed to claim deduction for bad debts fromtheir taxable income.Mandatory housing finance programs have been operating in countries likeFrance, Brazil and Mexico. Such schemes are established legislatively andrequire a proportion of salaries! wages to be allocated by the employer andemployees, for contribution to the housing fund163. n attractive feature ofthe mandatory contribution system is a flexibility of choice of alternativesin the disposal of funds. Similar programs may be adopted in India byintroducing enforcement measures for the large/medium sized commercial firmsand industrial undertakings.The success of a financial system will be dependent on the cost ofintermediation that would be reflected by the rate of interest at which afinancial institution can lend. This cost will be determined by factors suchas the cost of savings, management expenses, bad debt provision and after-taxprof it. Government may provide indirect subsidies such as tax advantages tothe finance institutions for the savings received by the mobilization of idle162lnterest on deposits with UTI are subject to an additional allowance of Rs. 3000.3urban India, (July-December, 1990)130funds of household sector, which would otherwise be kept in non-financialasset forms. Tax advantages to HFI5 may only be applied to certain lendingprograms that provide that a significant proportion of these subsidies will goto the targeted low income groups.8.3.5 HTEs do not directly impact low-income-groupsOne characteristic inherent in housing tax expenditures is that theirdirect effect is limited to tax-payers only, and the non-taxpayers, whogenerally belong to lower income groups164 are not directly affected by them.However, by increasing the total amount of housing activity, HTE5 haveindirect impacts in the form of generation of manufacturing activity andemployment opportunities for mainly unskilled and semi-skilled labour. Thisresults in increase in income of these groups, and thereby enhances theirchances of securing better housing. Increasing housing activity would alsomake more housing available to them by the process of “filtering”. HTE5 canalso result in provision of more housing for the lower income groups throughtax incentives given 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 atsubsidized prices, but subsidies limit the extent to which public services cancontribute to increase in housing supply, especially for the poor. If usershave to pay for the cost of the service according to quality, they will choosethe level of quality commensurate with their ability and willingness to pay;and the public agencies will have an incentive to provide services at164This is not always true in India, as incomes of agriculturists and certain other groupsare exempt, even though they may earn large incomes. However in large urban areas, suchexemptions rarely apply.131standards reflecting people’s willingness to pay. Where subsidies are widelyapplied, this incentive is generally absent at the level of the household andthe public agency. However, subsidized supply of housing should be limitedonly to the poorest sections and care taken to ensure that it is selectivelyand properly administered. Planning for low-income housing should ensure thatafter initial government grants or loans for housing, a revolving fund forrepairs, improvement and maintenance of housing is developed.Some other implications of housing tax expenditures are discussed in thefollowing sub-sections.8.3.6 Do HTEs Divert Resources from Other Sectors?Will the use of fiscal policy instruments to attract investment to thehousing finance sector result in the deprivation of other areas of theeconomy? Savings mobilization with the aim of housing investment would notnecessarily mean reduction of deposits in other financial institutions orinstruments, but rather a shift from informal sector financial relations toformal institutional relations. The results of research carried out in Indiashow that a contractual savings scheme by which people save a certain sum ofmoney over a period of years in return for an entitlement to a mortgage loancan increase the share of assets held by participants in financial forms165.Participants have not simply shifted financial assets among differentinstruments, but have reallocated their savings in favour of financial assetsthat would be available for investment anywhere in the economy during thesaving period. Thus, channelling of household savings through financialinstitutions can contribute to the strengthening of the financial market in165Bickicioglou, (1992) . Such savings schemes would also increase the total volume ofsaving, by reducing wasteful expenditure and conspicuous consumption.132the country as a whole.8.3.7 Rationalization of Tax PoliciesFiscal incentives provided under the laws relating to taxation ofincome, wealth, gifts etc. need to be rationalized to channel savings intoHFIs and to promote investment in housing activity. For those not eligible forsuch incentives, alternative incentive schemes, need to be designed. Provisionof concessions in taxes and duties on transfers, conveyances, leases andmortgages between developers or approved financial institutions and the firsthome-owners will be useful in encouraging the property to be registered at itsactual 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 thestate and local governments in order to curb speculation in vacant land and torelease such land for housing and urban development. The proceeds of such atax should go towards a shelter fund. A penalizing levy on vacant land wouldbring most of the really excess land into use or circulation166.A partial solution for the housing shortage lies in recognizing theconstruction business as an industry. Lending agencies offer better terms andinterest rates to businesses with industry status. Industries are alsoeligible for several tax concessions, such as reduced rates of income tax.A problem with the Indian housing market is that it operates partly inthe underground economy. Very few properties for resale are advertised, andthose that are listed do not show the price at which the property is offeredfor sale. This is primarily due to the fact that a significant proportion of166D’souza (1992)133the price is paid (and accepted) in black money- that is undeclared income.Government’s attempts to counter such use and proliferation of black money,through acquisition of ostensibly undersold properties, is made largelyineffective by procedural and legal delays. If more fiscal incentives aregiven for investment in residential property, then people may be encouraged toreveal the true cost of the property, thereby reducing the influence of theunderground economy. In the present situation, when the housing marketoperates significantly in the underground economy, fiscal incentives will notbenefit the persons who are investing their unreported income in housing. Asthe use of black money becomes more and more costly (through higher fiscalincentives) it may become less prevalent in the housing sector, resulting inthe formalisation of this sector. Reduction of flow of black money in theproperty sector, may eventually lead to a reduction in house prices.8.3.8 Designing of Efficient Housing Tax ExpendituresThere is a general consensus that an efficient tax system is one with abroad base, with simple rules to permit effective enforcement, and moderatemarginal rates. The increased use of tax expenditures to meet the needs ofpreferential social policies can make it more difficult to maintain a broadconsensus on what constitutes a fair tax system. Nevertheless taxexpenditures, especially housing tax expenditures, remain a useful tool in thehands of governments to achieve social policies.Gillis has listed three rules for incentive-oriented tax designers’67 indeveloping countries. The first rule, is to keep it simple. Complex provisionsand attempts to “fine-tune” the economy are not suitable in the circumstances167 As quoted in Bird and Oldman (1990) p131-132.134of developing countries. Tax incentives in such countries should therefore befew, simple and preferably be limited in duration, both to increase theirimpact on investment timing and to comply with the third rule stated later.The second rule, is to keep good records on who gets incentives, for how longand at what estimated cost of revenue forgone. In the absence of suchinformation, there is little chance that incentives will play any useful rolein development policy. Finally, tax incentives should always be subject to“sunset” Drovisions, requiring them to be explicitly evaluated in quantitativeterms periodically, and if not found worthwhile, terminated. It is probablybest to keep only simple incentives in the tax law and to charge the taxadministration 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 extensiveand detailed attempts to deflect private investment into preselected channels,often with no follow-up to see what really happens and with no set proceduresfor ensuring that tl infants so expensively fostered grow up to be fulltaxpaying citizens.”Broadening of tax base contributes to redistribution, because excludedincome is largely received by high income families. Studies of the impact ofthe budget on income distribution, in countries as diverse as the US,Colombia, Malaysia and Chile strongly indicate that if the budget is to serveredistributive purposes effectively, the primary emphasis must be placed uponthe expenditure, not the tax side of the budget169. Payroll taxes and taxincentives for investment, by definition do not impinge directly on the168Bird and Oldman (1990) p 132.169Gi11is, (1990) p 81.135incomes of the poorest 40 of the population in most developing countries170.The idea that taxes are desirable corrective devices in those cases wheregovernment intervention is warranted has been popular among economists atleast since Pigou in the 1930s. The conflict between the tax expenditure viewthat direct expenditure programs are the desirable means of governmentintervention, and the welfare economist’s view that taxes are the preferredinstrument for government to alter the allocation of resources, has not yetbeen addressed171.8.4 Recommendations for Further StudyThis thesis has reviewed the ways in which fiscal policies impacthousing and housing finance. Even though tax incentives are widely used, thejury is still out on the question of their efficacy. This is not surprising asthe notion that tax incentives are in effect tax expenditures and thus shouldbe evaluated in equivalence with direct subsidy programs, is comparativelynew, being expounded by Stanley Surrey in 1973172. While evaluation of taxexpenditures as an economic tool is difficult as their effect cannot bedetermined in the absence of any “control situation”, their effectiveness as asocial and political policy is even more difficult to analyze. These problemsare compounded in a country like India, where public policy is formulated inan overall interventionist framework and tax laws are complicated.There is considerable scope for further research in the ways taxexpenditures influence investment in certain sectors. Very little empirical1705ird and Miller, (1990) p 427.171Bruce, (1990) p 23.172 Surrey, (1973)136research has been done in developing countries, including India, regarding theways in which tax incentives, such as housing tax expenditures influenceinvestment decisions. The Indian Income Tax Act contains a large number of taxincentives, allowances and credits to promote a variety of activities. Thereare frequent alterations, deletions and additions in these tax expenditures,but no study has been done regarding either their cost in terms of taxesforegone, or whether they have succeeded in achieving their purpose. Whenthese concessions are introduced, they are generally welcomed by the sectorthey favour, but there are also demands to extend their coverage, in terms oftime and amount of concession. Any attempt to delete or curtail them is metwith vociferous opposition. However, there are no studies to show how thesetax expenditures fared in achieving their objectives. The need for such astudy is immense, as only then can fiscal policies be successfully formulatedto attain what they were designed for.In view of the present and predicted shortages of urban housing, it isessential to explore ways to increase the amount of housing finance available.However, the problem of urban housing shortage in India is very large andcomplex, and any attempt to solve it through an instrument such as housing taxexpenditures, that by definition directly impacts only the tax payers (onlylO of the urban population), is likely to have only a limited success.Nevertheless tax policy is a useful instrument to address housing shortage, asit impacts persons who have the money to invest. It would be useful to examinetax incentives designed to encourage investment in a fund that can be used forproviding housing finance to low-income residents in urban areas. Such a fundcould be given special tax incentives, similar to the Unit Trust of India, andthe amount of finance so mobilized can be used for providing credit to persons137in the low-income groups for housing. Such a scheme would substantiallyincrease the funds available for low-income housing. It would also be usefulto formulate tax incentives for mobilizing deposits towards finance of housingbuilt through cooperative group housing schemes.One of the main constraints for housing in urban areas is the shortageof land. Paradoxically in urban areas in India, large tracts of land lievacant, despite the acute shortage of land and housing. This is partly due tothe laws imposing a ceiling on urban holdings. The land recognized as excessunder this law is generally not available for development, due to litigationpending in courts against acquisition of such land. Land, and housing propertyare also held vacant for investment purposes, as land and property pricesescalate at a rate faster than inflation. There is a need to devise ways inwhich such vacant land and property is brought onto the market to eventuallyincrease the supply of housing. This can be in the form of vacant land tax asis levied by Taiwan. This will increase the opportunity cost of keeping theseproperties vacant, and may result in their being offered for rent or sale. Theproceeds of the tax can be used to provide finance for housing low-incomegroups. The increase in land supply should result in a fall in land prices,thereby making it more affordable.Another reason for the limited supply of serviced land in big cities ofIndia, is the fact that only a few government agencies are allowed to developsuch land (for example in Delhi, only the Delhi Development Authority candevelop and supply large tracts of land; private developers are not givenland) . This restricts the amount of land that comes onto the market and thusincreases the cost, exacerbating the housing shortage. Allowing privatedevelopers to develop land, and construct housing would increase the total138amount of housing. Competition among developers may result in lower pricesand increase in quality of housing. To provide low-income housing thesedevelopers may be required to supply a percentage of their production forthese groups at subsidized prices.A combined empirical research from the perspective of both urbanplanners and tax policy makers would be particularly useful in addressing theproblem of housing finance shortage. This research would provide a significantinsight into the designing of fiscal policy measures to successfully increaseavailability of finance for urban housing in India.139BIBLIOGRAPHYAcharya, S. (1988) “India’s Fiscal Policy” in Lucas, R. E. B. & G. 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Hardwick (1978) “Tax Expenditures in the UnitedKingdom” Heineman Educational Books, London.Willis, K. G. & S.J. Cameron (1993) “Costs and Benefits of Housing in TheNewcastle Area: A Comparison of Alternative Subsidy Definitions Across TenureSectors and Income Distributions” p51-64. in Maclennan and Gibb, 1993.Wood G. A. (ed.) (1986) “Tax Policies and Urban Housing Markets”. DECO UrbanAffairs Programme, Paris.Wood G. A. (1990) “The Tax Treatment of Housing: Economic Issues and ReformMeasures”. in Maclennan and Williams, p43-75.World Bank (1992) “World Development Report 1992” Oxford University Press, NewYork.144"@en ; edm:hasType "Thesis/Dissertation"@en ; vivo:dateIssued "1994-05"@en ; edm:isShownAt "10.14288/1.0099114"@en ; dcterms:language "eng"@en ; ns0:degreeDiscipline "Planning"@en ; edm:provider "Vancouver : University of British Columbia Library"@en ; dcterms:publisher "University of British Columbia"@en ; dcterms:rights "For non-commercial purposes only, such as research, private study and education. Additional conditions apply, see Terms of Use https://open.library.ubc.ca/terms_of_use."@en ; ns0:scholarLevel "Graduate"@en ; dcterms:title "Effect of fiscal policy on housing finance in India"@en ; dcterms:type "Text"@en ; ns0:identifierURI "http://hdl.handle.net/2429/5057"@en .