A tough but inevitable choice

The debate over whether cuts to the real estate acquisition tax should be permanent has led to a head-on clash between the Ministry of Security and Public Administration and the Ministry of Land, Infrastructure and Transport, to the extent of irking the president. Slight signs of recovery in the real estate market were dampened when the acquisition tax went back to 4 percent after having been halved by the Lee Myung-bak administration since September of 2012. The tax break was extended for three months twice and expired at the end of June.

Few disagree that the legal tax rate of 4 percent imposed on individuals and companies buying real estate in Korea is too high when compared with global standards. The tax rate for property ownership is also too low.

But there are a range of opinions on how society can accommodate changes in tax rates by lowering the acquisition burden and increasing taxes related to ownership. Some are demanding a revival of cuts to the acquisition tax to give the real-estate market a short-term boost, while others oppose the plan because local governments are struggling without the extra revenue.

Taxation on real estate has changed greatly since 2006, when reporting of all real estate deals became required by law. Before that time, people were taxed based on the value they reported their real estate to be, so many underreporting was widespread. When the new rules went into effect, acquisition and registration taxes lowered de facto to 2 percent in order to prevent a sharp rise in tax burden when properties were reported at their real value, which was usually higher. Still, revenue from acquisition and registration taxes doubled in 2006 over 2000. The real estate market was booming at the time, generating huge tax revenues when taxes were based on the actual purchase price. The surge in revenue might have been a boon for local governments, but those were not normal times. The total 4 percent tax rate the buyer had to pay to buy real estate only has been maintained for some specific periods since. It needed to be permanently adjusted one day.

Determining the tax base for property purchases is tantamount to figuring out the normal level of real estate trade while attempting not to trigger speculation. Trade volume, measured against housing inventory, fell to about 7 percent in 2012 from 11 percent in 2006 across the nation. Trade against available housing around the capital plunged to around 6 percent last year from 15 percent in 2006. In other major cities except Incheon, it bottomed out from 8 percent in 2007 to recover to 11 percent in 2011. Trade volume over the years in areas around the capital and major cities averaged around 9 percent.

In simple math, if real estate trade around the capital, which accounts for about 6 percent of the housing inventory, recovers to the long-term average of 9 percent, revenue from acquisition taxes could jump 50 percent. The revenue would jump 200 percent when the legal tax base of 4 percent is applied. This is simple math.

To fiddle with acquisition tax rates as a means to lift the real estate market out of its protracted slump is a risky choice in the long run. Local governments are confronting a decrease in real estate tax revenues not because of the temporary acquisition tax break, but due to the stagnant market. Depending on acquisition tax as a revenue source doesn’t help local governments maintain stability. Local governments must endure the burden from the housing market problems instead of whining about the fall in revenue caused by the tax cut.

Local government finances, as far as real estate taxes go, can best be improved by normalizing the housing market. An overall revision of tax bases - higher property taxes and lower acquisition taxes - may not come easy. But it’s the best solution for long-term stability in local governments’ finances.

Translation by the Korea JoongAng Daily staff.

*The author is a professor of urban planning at Hanyang University.

By Lee Chang-moo