China Tax Rattles Public

An analysis by Michael Lelyveld
china-property-march-2013.jpg A man walks past a property development billboard in Shanghai on March 6, 2013.

China's new government may be off to a rough start after planning to slap property owners with a major tax increase.

On March 1, the State Council abruptly announced a series of measures to cool prices in the overheated housing market, including a tax on profits from home sales of up to 20 percent.

The government also called on banks to raise down payment requirements and mortgage rates on second home purchases, the official Xinhua news agency said.

Among other measures to discourage real estate speculation, the government barred "non-local families" owning one home or more from "buying homes in the cities in which they currently reside," according to Xinhua.

'Clumsy'  policy

The complicated and seemingly contradictory restrictions sowed widespread confusion among homeowners, investors, and speculators alike, with a host of unintended effects.

"The Chinese are pretty adept at policy in most areas, but this is an extremely clumsy exception," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.

In the bewildering barrage of directives, most attention focused on the steep hike in the "income" or capital gains tax on profits from home sales, previously set at between 1 and 2 percent.

Instead of cooling the market, the tax turned the heat up even higher as both buyers and sellers scrambled to beat the increase, since the government neglected to say when it would take effect.

One real estate group reported a 30-percent jump in real estate inquiries and demand the day after the announcement. Property bureaus in major cities were packed with people, state media said.

In Beijing, second-hand home sales nearly doubled, China's reported. About one-third of potential home buyers planned to speed up their purchases after the State Council announcement, the official English-language China Daily said.

In the confusion, the new rules also sparked a surge in divorce filings as a way to dodge second-home rules, the London-based Financial Times reported, although the initial reports said the tax would apply to all home sales.

"A capital gains tax on housing sales was intended to cool China's sizzling property market, but since it was announced last Friday it has had the exact opposite effect: a panic has been unleashed," the paper said.

Confusion also reigned over whether the tax was a new one or an old one. A 20-percent levy was originally announced in 1994 but never strictly enforced, according to the South China Morning Post.

Major goal lost?

The major goal of restraining prices and making housing more affordable for poorer families may have been lost.

The China Daily cited concerns that prices would rise as sellers shift the cost of the tax onto buyers. Officials are trying to keep that from happening, but how is unclear.

"Whoever gains from property sales should pay the tax," said Vice-Minister of Housing and Urban-Rural Development Qi Ji.

Within days of the announcement, officials started backtracking on how the tax would be applied.

Qin Hong, a housing ministry researcher, suggested that homeowners who sold their property after holding it for five years would be exempt, the People's Daily reported.

Vice-Minister Qi pledged to protect "non-speculative buyers," but did not say how.

Announced 'out of the blue'

Gary Hufbauer cited several flaws with the government's handling of the announcement, most notably the huge size of the tax increase and the lack of an effective date.

"All in all, I would say the policy didn't show the usual Chinese finesse," he said.

Hufbauer also noted the stark contrast with tax change proposals in Western countries, which are subject to months, if not years, of public debate.

"Just to have it announced out of the blue, you can't do that in a country with any level of democracy at all," he said.

Off to a bumpy start

Lowell Dittmer, a China specialist and political science professor at University of California Berkeley, said the tax announcement just days before the convening of the National People's Congress (NPC) appeared to be the result of miscalculation.

"They underestimated the popular response, I guess. They thought they could just do it," Dittmer said. "It's a new leadership. Maybe that accounts for it."

Major policy changes have usually been more careful and gradual, using pilot programs and a "stone to stone" approach, Dittmer noted. "This is much more amateurish," he said.

But the timing of the announcement makes it hard to tell whether it was the work of the old State Council under outgoing Prime Minister Wen Jiabao or the new leadership.

"It's really in flux," Dittmer said. "Maybe it's a sort of valedictory (move)."

If that is the case, the new leadership may have its hands full in trying to keep the tax policy from backfiring and carving out exceptions to make it work.

Hufbauer sees it as a bumpy beginning for the new government.

"To have a clumsy misstep like this as one of its first major initiatives which will effect lots of people certainly undermines credibility," he said.

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