7

## **Box 2: South Africa’s Property Tax System**

South Africa has introduced a promising solution to the valuation of subnational property and, at the same time, a mechanism for making institutions that hold valuable public property feel the opportunity costs of continuing to hold such property. Under South Africa’s Municipal Property Rates Act (implemented in 2005), public property is assessed at market value using the same valuation techniques that are used for assessing private property. Public property owners also must pay property tax, following the same principles as private property owners. Land is valued separately from improvements at market rate.

Source: Pillay, Tomlinson, and DuToit (2006).

# **_Volatility of Financing Capital Budgets_**

Publicly owned urban land assets are in limited supply. Although urban authorities can acquire new land at the urban fringe, and under certain conditions can acquire land through condemnation or eminent domain, urban land cannot be “produced” indefinitely. Sale or leasing of public land is not a “recurring” source of revenue. For this reason, revenues from the sale or other disposition of public land should be treated as one-time revenues, with proceeds used to finance investment in urban infrastructure assets or finance other one-time expenditures such as major institutional reforms. In countries that have formal capital budgets, revenues from land sales typically are designated for budget purposes as capital revenues. They are used to finance activities eligible for spending under the capital budget, along with other sources of capital revenue such as borrowing and carryover of savings from the operating budget. The City of Warsaw, Poland, for example, following national financial reporting rules, shows the proceeds of all property sales, as well as the proceeds of land sales, on the revenue side of its capital budget (Warsaw City 2010).

In moderation, the use of land-based revenues for capital finance should reduce overall capital financing risk. Land sales, upfront land leasing, and contributions of land to infrastructure joint ventures all generate revenue or assets up front. Land transactions of this kind complement other types of financing by reducing uncertainty about future financing sources. When land finance substitutes for borrowing, it reduces the risk surrounding future debt repayment capacity and the need to generate future revenue streams to meet future debt service.

Extreme reliance on land assets to finance urban capital budgets, however, creates risks of its own. Urban land markets are highly volatile, especially in developing countries. Land prices can undergo swings of 50 percent in either direction, and in times of crisis even more, as demonstrated during the Asian financial crisis of the 1990s (Mera and Bertaud 2000) and again during the market collapse starting in 2008. Demand for land development can collapse in volumes as well as in price. Volatile land prices and swings in developer demand for land conversion combine to create volatility and uncertainty in this source of capital finance. Box 3 illustrates for Mumbai, India the effect that such volatility can have on capital budgets, when revenue from land asset sales or upfront land leasing is a main source of public infrastructure finance.

Other examples of volatility abound. Hong Kong, China between 1996 and 2000 raised via land leasing revenues an amount equal to 130 percent of its expenditures on public works and 18 percent of its entire budget expenditures. However, land prices and demand for land fell precipitously as a result of the Asian financial crisis, leading Hong Kong, China to suspend land leasing altogether between 2001 and 2003. The loss of revenues from land leasing contributed to steep fiscal deficits that at their peak reached 30percent of fiscal revenues (Hong 2003; Peterson