Report No. 37456-PA Paraguay Real Property Tax Key to Fiscal Decentralization and Better Land Use (In Two Volumes) Volume I: Main Report May 16, 2007 Poverty Reduction and Economic Management Unit Latin America and the Caribbean Region Document of the World Bank ACKNOWLEDGMENTS This report was preparedby ateam ledbyPeterM.Hansen(Lead Economist, LCSPE) and comprising Malcolm D. Childress (Sr. Land Administration Specialist, LCSER), Anna Corsi (Land Administration Specialist, LCSER) and Jasmin Chakeri (Young Professional/Economist, LCC7). The analysis of rural landmarketvalues inthe Departmentof Caaguazuwas carried out by the Paraguayanconsultant firmAsociacibn Tavamba'e under the direction of Economist Victor Rivarolaand comprising Jorge Irala (Technical Coordinator and Cadaster Specialist), Francisco Hemhndez (Geographic InformationSystem Specialist) and Wilfrido Ramirez (Assistant GIS Specialist). Analysis of municipal finances was preparedby Blas Cristaldo of the Paraguayan consulting firm COPLANEA, based on data contained ina JICA study, "Construction of a Data Base of Municipal Finances" (2004). Ignacio Urrutia (consultant) and Gustavo Saguier (JPA) provided statistical support on the analysis of fiscal values and central/municipal Government finances, respectively. Florencia Liporaciprocessedand formatted the final report. Preface This report was presented to the Ministryof Hacienda (Finance) inMarch2007 in atechnical meeting that included representatives from the National Cadastre Service, the Rural Development and LandAdministration Agency (INDERT), the Ministry of Agriculture and representatives from the Vice President's Office, which deals with rural land issues. The report was subsequently presentedto the ParaguayanOrganization of Inter- municipal Cooperation (OPACI), which acts as forum for the mayors of the approximately 220 municipalities of Paraguay. The report was also presented to the international donors who participate inthe localworking group on decentralization. At the same time, the localpress ran a series of articles onthe mainmessages ofthe report during the secondhalf of March. The report i s currently being printedinSpanishfor wider dissemination in Paraguayto other audiences with interest inthe localproperty tax, such as the Council of Governors, rural organizations including small farmers andthose inthe modern agricultural sector, and economic researchgroups. It will also be available on the internet page of the Bank for Paraguay, www.bancomundial.ora.Pv. Itis worth notingthe following inresponseto various points raised inthe above discussions. Although the data on landdistribution comes from the 1991census, the most recent census for the entire country (table 1,l), pattern of land ownership inthe the EasternRegion does not appear to have changedsignificantly between 1991and 2002 (see Table 3.1). The incrementinlandvalue assessments for 2007 (10 percent) followed the same pattern as during the past 15 years, namely no change inreal terms, given inflation of 12.5 percent inthe preceding year, 2006. The report's estimates of rural landprices inthe Department of Caaguazfi, the subject of Chapter 2, were calculated inJune of 2006 at an exchange rate of G6,000 per US$. These values may well be underestimatedinview of the recent appreciation of the Guarani to about G5,000 inMarch2007. Table of Contents Executive Summary ....................................................................................................................................... i Chapter I:Land Issues and Property Taxation in Paraguay Today ....................................................... ExistingPatternsof Land Ownership......................................................................................................... 1 1 Assessment ............................................................................................................................................. 4 ExistingProperty Tax (Impuesto Inmobiliario. Ley 125/91) ..................................................................... 5 RecentAttempt at Reform ...................................................................................................................... 9 Overview of Municipal Finances ............................................................................................................. 11 Property Taxation within the Context ofParaguay's Overall Tax Structure ............................................ Institutional Capacity at Municipal Level ........................................................................................... 16 16 Chapter 11: The Market Value of Rural Land - Case Study of the Department of Caaguazu ...........20 Rationale for choosing Caaguani............................................................................................................. 20 20 Description of methodology usedto estimate market value..................................................................... Summary of main characteristics ........................................................................................................ 22 Determination of the sample................................................................................................................ 22 Collection of information on samplepoints Estimating market values..................................................................................................................... 24 ......................................................................................... 23 Analysis of Results................................................................................................................................... 27 a) Thegap between market andfiscal values in rural areas ............................................................... 27 b) Potential revenue impact of moving the tax base to market values ................................................. 30 .................................................................................... 34 Conclusion................................................................................................................................................ SigniJicance offindings for other departments 36 Chapter 111: Evaluating the Relationship of Land Taxation to Non-revenue Policy Goals in Rural Paraguay ...................................................................................................................................................... 37 What the literature has to say aboutnon-revenueimpacts of landtaxation .............................................. 38 LandUtilization and Markets inParaguay............................................................................................... 40 Effect of LandTax on the Market Value of Land.................................................................................... Conclusions.............................................................................................................................................. 43 45 Chapter IV: International and Regional Experience with Property Taxation ...................................... Tax base............................................................................................................................................... 46 48 Tax assessment .................................................................................................................................... 51 Tax rates .............................................................................................................................................. 52 Agricultural/rural land ........................................................................................................................ 53 Tax administration ............................................................................................................................... 54 Somegoodpractices ............................................................................................................................ 55 Chapter V: Conclusionsand Policy Options ............................................................................................. Core Findings ofthe Report ..................................................................................................................... 56 56 Options for StrengtheningMunicipal Finance Administration and Property Tax Collection ..................61 Options for Making the Property Tax an Effective Revenue Instrument................................................. 58 Reflections on Land Tax Policy and Land Distributionto the Poor......................................................... 63 Bibliography ................................................................................................................................................ 73 Map - IBRD 35231, Paraguay -Regions and Departments .................................................................... 76 List of Tables 1 Table 1.2: Increase inFiscal Values vs. Inflation inPreviousYear. 1993-2006............................................. Table 1. 1:Number and Area of Farms inParaguay. by FarmSize. 1991...................................................... Table 1.3: IncreaseinFiscal Values inReal Terms (%) ................................................................................. 7 8 Table 1.4: Composition of Municipal Revenues, 2003 ................................................................................. 13 14 Table 1.6:Evolution of Central Government Revenues, 2000 -2005.......................................................... Table 1.5:Key RevenueStatistics for All Municipalities (Asunci6n + Interior), 1999 - 2003 ..................... 18 21 Table 2.2: Patternof agricultural landholdings inCaaguani ....................................................................... Table 2. 1CaaguazuRural population and landby district (2002) ............................................................... 21 Table 2.4: Summary of EstimatedMarket Values by Type of Land(US$) ................................................ Table 2.3: Marketvaluesby ZHE (inUS$ per ha.)...................................................................................... 25 Table 2. 5: Fiscalvalues (2006) vs.estimatedmarketvalues inCaaguazd................................................... 26 29 30 Table 2. 7: Revenueperformanceofruralproperty tax (Gs.) ....................................................................... Table 2.6: Comparisonofestimatedmarket values (Gs.per ha.)................................................................. 31 Table 2. 8: Caaguani- potentialrevenues fromruralpropertytax at market values (Gs.) ........................... 33 Table2. 9: Potentialadditionalrevenue from INDERTtransferredlands................................................... 34 Table 2. 10:Potentialimpact ofpossible exemptionofnaturalforests from propertytax............................ - 34 35 Table 3 1: Quantity andArea ofAgriculturalLandholdingsinEasternParaguayby FarmSize.................41 Table 2. 11: Paraguay potential revenues from ruralpropertytax at marketvalues (US$) ........................ . Table 3.2: LandUse inEasternParaguay, by FarmSize (2003).................................................................. ....................................................................... 42 44 Table4. 1: Taxes onproperty, 1970-2003,inpercentof GDP, regionalaverages........................................ Table 3. 3: Effectof LandTax on the MarketValue of Land 46 Table 4 2: Taxes on property, 1970-2003inpercent oftotal tax revenues.................................................. 46 Table 4 3: Relative Importanceof PropertyTaxes, 2003 ............................................................................ .. 47 Appendix Table 1:Number andArea of FarmsinParaguay, by FarmSize, 1991....................................... Table 4. 4: ComparisonofPropertyTaxes among Sample OECDandLatinAmerican Countries..............49 64 Appendix Table 2: Key MunicipalTax andExpenditureRatios, 1999-2005(inpercentof GDP)...............65 Appendix Table 3: Paraguay Structure of Central Government Revenues(inbillions of guaranies) - .........66 Appendix Table 4: Caagani-FiscalandMarketValues for RuralLandby DistrictandType of Land......67 Appendix Table 5: Caaguani Marketvalue ofINDERTlands, indigenous landsandforests, - ...................70 Appendix Table 6: Actual andpotential collections from the ruralpropertytax inCaaguani..................... 71 Appendix Table 7: Official estimatesof landmarketvalues for 2005 for EasternParaguay (Guaranies per ha.) .......................................................................................................................................................... ~~ 72 ListofFiguresand Maps Figure 1.1: CumulativeIncrease inFiscalValues vs. Inflation(1992 = 100)................................................. 8 Figure 1.2:Compositiono fMunicipalRevenuesfor 222 Municipalities ofthe Interior,2003 ...................12 Figure 1.3: CompositionofCentral GovernmentRevenues 2005 .............................................................. - 19 Figure 1.4: Revenuesofthe CentralAdministrationandMunicipalities,2005 (as percent of GDP) . 1 ...........19 Map2. 1: PhysicalZones (ZF) with Sample Points...................................................................................... Figure2 : Average market values by district (inUS$ per ha.) ................................................................... 28 23 24 Map 2. 3: HomogeneousEconomicZones (ZHE; inUS$per ha.) Map2.2: Rangesofmarket values inCaaguani(inUS$ per ha.)................................................................ . ............................................................... 25 27 Map 2. 5: Marketvalues expressedas multiples of fiscal values.................................................................. Map2 4: Average market valuesby district(inUS$ per ha.)...................................................................... 29 ListofBoxes 2 Box 1.2: ProposedTax onRuralWealth(PatrimonioRural)....................................................................... Box 1.1:Fifty Years ofAgrarian Reform. 1950-2000.................................................................................... 10 Box 1.3:New AgriculturalIncomeTax (Zmagro) ......................................................................................... Box 4. 1: Self-assessment.............................................................................................................................. 17 52 Executive Summary i. ThisstudyhasatitsoriginthelandquestioninParaguay,namelythatland ownership i s highly concentrated and has become a source o f social conflict inthe rural areas where one-half o fthe population lives. A central thesis o f the study i s that the existingpatterns o f landuse andownership, inparticular, the very large land holdings (Zatifundio), are a reflection inpart o f the almost insignificant landtax that is charged today on rural properties. Although the property (land) tax is governed by national legislation, it i s collected by the municipalities, which are constitutionally autonomous from the central government. The study thus examines municipal finances inParaguay and estimates the revenue potential o f a revised property tax. The study also reviewsthe economic rational for effective land taxation andthe international experience inthis regard. Finally, it suggests improvements inmunicipal financial administration that are needed in general and, inparticular, to administer a revamped and more effective land tax. .. 11. Paraguay has one o fthe most skewedpatterns o f landownership inthe world -- 2 percent o f the agricultural establishments (about 6,400 farms) occupy 82 percent o fthe agriculturally exploited land(namely, 20 million o f the 24 million hectares inagricultural use, or one-half o f Paraguay's total area o f 40 million hectares). Duringthe second half o f the 20thcentury, a program o f "agrarian reform" contributed to these skewed patterns o f land ownership. It distributed about 12 million hectares o f land, but 74 percent o f it went to only 2.5 percent o fthe beneficiaries. The agrarian reformnevertheless also benefitedlandless rural poor -about 160,000 families were settled on 3 millionhectares, butvery few o fthese have title to their land. iii. Theexistingpropertytax(impuestoinmobiliario,Ley12.51'91)coversallurban andrural land and levies a basic rate o f one percent on the fiscal value o fproperty. The existing legislationincorporates many desirable characteristics from an international comparison point o f view, but nevertheless suffers from a few key shortcomings, namely that the fiscal values used for assessment are only a small fraction o f marketvalues -the study estimates 2 percent for rural land-and that the tax law stipulates that fiscal values cannot increase by more than inflation, thus locking ina permanent situation o f undervaluation. Fiscal values have actually declined inreal terms since 1993. Also, the nominal adjustments have not taken account o f land market price developments in different regions, leadingto wide disparities inthe relation o f fiscal values to market values across Paraguay. iv. Despite low fiscal values, one-quarter o f municipal government revenue i s derivedfrom the property tax. However, municipal budgetsare relatively small in Paraguay (about 1.5 percent o f GDP), and the property tax amounts to only 0.4 percent o f GDP (as opposed to 0.8 percent for LatinAmerican countries and 1.9 percent for OECD countries). Furthermore, the great majority o f actual property tax collections (about 90 percent) originates from the urbanareas. Inrural areas, the cost o f collection often outweighs the revenue, and it i s customary that rural property taxes are paid mainly when i property is sold or mortgaged, at which point severalyears of back taxes may be negotiatedor forgiven. v. An important trend inmunicipal finances is the rapidly growing stream of royalties since 2000, whenthe central government beganto share the royalties it receives from the Itaipuand Yacyreta hydroelectric dams with the municipalities. By law, the municipalities should eventually receive 40 percent of total royalties which, at current levels, would be equivalent to 1.6 percent of GDP -- more than their entire budgets at this time. At present, municipalities receive only about 5 percent oftotal royalties, butare positioned to receive a significant increasing flow ofresourcesinthe near future. This situation poses a moral hazardthat the municipalities may relax their own "genuine" revenue collection efforts, inparticular the property tax. It also requires an urgent improvement intheir financial management capacity, which is rudimentary. vi. Paraguayhas a relatively well balanced overall tax structure, following major of income and consumption -- company profits, personal income, agricultural income and reforms in 1991 and 2004. The structure is neutral with regardto taxing different sources value added are all taxed at a uniformrate of 10 percent. Customs tariffs are governedby the common external tariffo fMercosur, andexcisetaxes are lowby regional standards. The main lacuna inthe overall tax structure is the local property tax, which yields insignificant amounts of revenue due to the low fiscal values used for assessment. vii. Central government tax revenues amount to 13 percent of GDP. Non-tax revenues, mostly royalties, bring total resources upto 18 percent of GDP. Incontrast, the municipalities have total resourcesof about 1.5 percent of GDP, or about 8 percent of total (central plus local) revenue. viii. Chapter 2 presents the findings of a detailed study of landmarket values inthe Departmentof Caaguazu, whichis centrally located inthe Easternregion of Paraguay and containsmost of the predominant types of landuses inthis region-some remaining forests, multiplesmallholder settlements, extensive cattle ranching and soybean farming. ix. Basedon a representative sample of 455 properties, the study estimates the average value of landinCaaguazuat US$l,100per hectare. Landvalues range from an average of US$360 inthe district of Carayaoto an averageo f US$1,969 inthe soy farming district of JosC Eulogio Estigarribia. This wide variation inmarket values stands insharp contrastto the low levelandvery narrow rangeof fiscal values applicable to the 20 districts inCaaguazu, which range from US$17 to US$29 per hectare. Despite annual increasesinnominalterms, these fiscal values have remained exactly the same inrelative terms since 1992 (Le., ina ratio of 17:29) and do not reflect the considerable changes in market values that occurred during the past decade. x. As aresult, some of the districts with the highest market values (Mariscal Lbpez, for example, at US$1,642 per hectare) are still assessed with the lowest fiscal value (US$17 per hectare). The average market value o f land inMariscal Lopez is thus 99 times the fiscal value. InSan JosC de 10s Arroyos, onthe other hand, market values are .. 11 only 13 times the fiscal value. On average, the market value of land in Caaguazu (US$1,100) is estimatedto be 54 times the average fiscalvalue of US$20. Conversely, the averagefiscal value is only 1.8 percent ofthe averagemarket value. xi. Aside from very low fiscal values, the actual collection of ruralproperty taxes in Caaguazuis far below potential. It i s estimatedthat Caaguazuas a whole collects only 35 percent of the taxes actually due on rural properties. Improvinglocal tax administration and collection alone could triple actual rural property tax revenues, from Guaranies375 millionto Guaranies 1,049 million. Changingthe tax base from fiscal values to full market values has the potential to increaserural property tax revenuesin Caaguazuby a factor of 63, to Guaranies 66,396 million (about US$l1million), assuming full collection. xii. Beneficiaries ofthe agrarian reform occupy an estimated one-quarter of the land inCaaguazu, butmost are not yet subject to property taxes dueto alack oftitle to their lands. Iftheir lands were properly titled and subject to tax at the estimated market value, the potential additional tax from these properties is estimatedat Guaranies 18,12 1million per annum (about US$3 million). Inaddition to the economic incentives for investment that landtitles would provide to landowners, there i s a strong cost-benefit case for providingimmediate free titles to the beneficiaries of agrarian reform so that they will start paying property taxes as soon as possible after the statutory five-year grace period. xiii. Using indicative market values for rural land for the other Departmentsof Paraguay, the total tax potential from the property tax on rural landi s conservatively estimatedat US$103 million per annum, equivalent to about 1.1 percent of GDP. This compares with actual property tax collections on rural landestimated at only 0.04 percent of GDP.' The difference betweenthese two estimatesrepresents the opportunity cost of maintaining the existing property tax regime. It also represents the potential for increasing local expenditures and achieving a sustainable fiscal decentralizationthat i s financed with own-source "genuine" tax revenues. xiv. Chapter 3 reviews the academic arguments for landtaxation which suggest that landtaxation increasesthe intensification of agricultural landuse and leadsto some reduction inlandconcentration. While the Latin American experienceswith land taxation have not yet demonstratedsignificant landuse changes, this appearsto be due to the region's weak property tax administration, below-market-value assessments, lowtax rates, and low collection rates. xv. An assessment of landuse inParaguay suggests that there is widespread underutilization of land. This conclusion is reached indirectly through observation of highland concentration inan economy inwhich the productivity of small farms has been shown to be higher than large farms (when controlled for access to capital), the high percentageof landdevoted to extensive cattle ranching (55 percent of land inthe Eastern 1 Total propertytaxes inParaguay are 0.4 percent ofGDP, ofwhich0.2 percentis Asuncion and0.2 percentfiom all the municipalities ofthe interior. Propertytaxes inthe interiorare mostly derived from urbanproperties, with taxes on rural landestimatedat only 20 percentoftotal, or 0.04 percentof GDP. ... 111 Region and most o fthe Chaco), data on the returns to cattle ranching versus high-yield soy production, the abundance o f agricultural labor, and the absence o f significant tax revenues from rural landwhich permits underutilizedland to be heldwithout cost. Inthis context o f widespread underutilization o f land, a significant tax on rural land would likely intensifylandutilization and reduce speculative landholding. xvi. Chapter 3 also examines whether a landtax would induce market transfers from larger to smaller farms and concludes that a realistically designed land tax should induce landholders to increase the intensity o f landuse (e.g., improve pastures, adopt rotation o f herds) inorder to increase returns per hectare, or to reduce their investment inland holdings through sale or rental o f excess land. This should increase the supply o f land to the market, probably resulting infurther redistributionfrom very large holdings to mediumsized farms, a trendalready apparent inthe Paraguayanlandmarket since the beginning o fthe soy boom. Redistribution to small capital constrained farmers would not readily occur however, but because a higher landtax would lower the market price o f land, it would facilitate the existing program o f agrarian reform and thus be part o f a more comprehensive land redistribution policy. xvii. Chapter 4 provides a comparative overview o fproperty and agricultural land taxation insix OECD and five LatinAmerican countries (including Paraguay). Itnotes the importance o f property taxes infinancing local government expenditures for, e.g., security (police), education and roadmaintenance. Italso notes the positive synergies that are created when locally raisedtaxes are spent locally for the benefit o f local tax payers, thus promoting greater citizen identification with the benefits of their taxes and better citizen control o f expenditure. xviii. Best practices are identified from this international experience that are suitable to Paraguay, for example: Usingmarket values as the basis for assessment, periodic reassessments, and an appeal process with transparent procedures. However, where a complete cadastral system i s not yet available, as i s the case inParaguay, it i s preferable to buildup the listing o fproperties and expand the tax base inalternativeways, rather than to wait for a full cadastral system, which can be completed at a later stage. Self-assessment can be an effective substituteor supplement to administrative assessment systems and can act as a transitional mechanism untilan effective property tax administration i s established. Self-assessment i s a l o w cost approach compared to cadastral parcel by parcel valuation and involves lower risk o f appeal. It i s an effective solution to increase the tax base when there is strong pressure against updating assessedvalues, as well as administrative difficulties in undertakingvaluations. Self-assessment may be combined with area-based assessment, whereby a minimumtax base i s established according to the property size and then adjusted by the self-assessedvalue. iv Good practice suggests giving local government discretion insetting the tax base and tax rate, but incountries with weak administrative systems like Paraguay, setting a uniform tax rate at the central level appearsjustified inorder to avoid distortions inland markets and/or to avoid tax competition between neighboring municipalities. Inthis regard, the existing legislation that sets a uniform base tax rate o f 1percent appears appropriate. 0 Tax exemptions and relief are not generally justified inthe case o f agricultural lands. However, reliefmechanisms canbe considered inthe case o f small, poor landholders. Similarly, tax exemptions can provide an effective tool for protecting and managing environment and natural resources, inparticular, forests. xix. The principal conclusions o fthe report are presented inChapter 5 and can be summarized as follows: a) There i s a very highconcentrationo f land ownership inParaguay, and a considerable array o f evidence points to significant underutilization o f land. b) The existing property tax law incorporates manydesirable features when compared with international experience, such as a uniformbasic tax rate. However, it i s not a meaningful instrument o ftax policy because the tax assessment i s based on fiscal values that are abnormally low as a percentage o f market values (on average, 1.8 percent for rural land inCaaguazu). Moreover, the property tax law effectively locks-in the undervaluationof land by prohibiting increases infiscal values inexcess o f inflation. An amendment to this provision o f the property tax law would be required inorder to make it a meaningfultax policy instrument. c) Given the limited capacity inParaguay for updating fiscal values to reflect the actual and constantly changing market values o f land, international experience indicates that a self-assessment system could be a viable alternative. d) The revenue potential o f a meaningful property tax on rural landis considerable and could generate about US$lOO million per annum, or 1.1 percent o f GDP. e) Property tax revenues from rural lando fthe above magnitude would double the resources currently available to municipalities o fthe interior andrepresent an important step towards greater fiscal decentralization. f) The financial administration capacity o fthe municipalities o fthe interior appears to be weak and needs to be upgraded substantially ifthe municipalities are to become effective agents o f fiscal decentralization. g) Internationalexperience indicates that the positive non-revenue effects o f a more effective rural landtax are likely to improve other long-term V development issues inParaguay, namely, the underutilization o f agricultural land, excessive land concentrationand the cost o f financing the existing program o f agrarian reform. xx. Based on the above conclusions, Chapter 5 proposes various policy options for makingthe property tax a more effective instrument and for improving municipal financial administration. xxi. Rather than incurring the expense and long gestation period o f creating a full national cadastre, consideration could be given to incorporating into a revised property tax law a system o f self-assessment o f property values that would require rural property owners to declare the market value o f their property as the basis for the tax. Such a systemo f annual self assessment would buildon one o f the innovative features proposed inthe draft legislationfor creationo fa newtax onruralwealth (Box 1.2). A self- assessment systemwould have the advantage o f developing a market value tax base quickly and should more easily capture changing landmarket conditions than a formal cadastre system. Self-assessment would also avoid the political resistance created each time the government adjusts the tax base, becausethe owner himself would propose the property value rather than having it imposed from above by the government xxii. The self-assessment system could be phased inover five to seven years, starting withthe largest properties, inorder to provide time for the municipalities to increasetheir capacity for administering the property tax, including the processing o f self-assessment declarations. Duringthis transition period, fiscal values would continue inforce for properties not yet covered by the self-assessment requirement. To reduce the underestimationo f property values, self-assessedvalues could be publicly disclosed (again, as proposed inthe draft legislation for the rural wealth tax). Also, the value o f a property for guaranteeing a mortgage could be limitedto the declared self-assessed value. An appeal process could be established at the Department levelwithpower to adjust self- assessmentsthat are significantly undervalued. Penalties for not providing an annual self-assessment would need to be established, as well as powers to seize and auction properties that have not paid the tax after two years. xxiii. To ease the transition to highertaxes based on market values, a tax rate adiustment period could be considered during which the existing tax rate o f one percent could be lowered on self-assessed properties and then climb back up to the full one percent rate over time. This adjustment period would partially compensate the significant jump intaxes that will occur when shiftingfrom the existing low fiscal values to the higher self-assessedmarket values. The lower rate should apply only to those properties that have entered the self-assessment process, however. xxiv. Other modifications to the property tax legislationthat could be considered include (i)the elimination o fthe existing schedule o f additions and reductions to the basic 1percent tax rate for certain landholding categories (very large properties and those under five hectares) inorder to avoid artificial sub-division o fproperty, (ii)the elimination o f certain exemptions such as for political parties and private sports clubs, vi and (iii) immediate and cost-free titling o f landfor beneficiaries o f the agrarian the reform to provide them security over their landasset andto get them onto the property tax roles as quickly as possible following the five year grace period the law currently provides. xxv. Finally, inview o fthe widespread deforestation that has occurred over the past fifty years, a newexemption for natural forests that are managed ina sustainable manner could be considered. The criterion for the exemption could be that the owner maintain in good standing a certificate o f sustainable forest management from a private certification service (of which there are several working inParaguay). xxvi. While municipalities are constitutionally autonomous andresponsible for their individual finances, the central government and the nation have a vested interest inthe sound administration o f the municipalities and, inparticular, inthe efficient implementation o fthe property tax which remains governed by national legislation. Also, royalty payments are increasing quickly and the municipalities need to improve their financial administrationurgently to managethese resources more effectively. xxvii. For these reasons, the Ministry o f Haciendacould consider creating a national program o f technical assistance with the aim o f upgrading the financial administration o f all municipalities to minimumnational standards by 2010. The main components o f such a program could include the establishment o f a uniformmunicipal chart o f accounts, creation o f appropriate financial administration software, training and upgrading o f human resources at the municipal level, and a public relations campaign to increase civic awareness o f municipal finances and local accountability. xxviii. Consideration could also be givento the "moral hazard" problem o f rapidly increasing royalties andthe disincentives this may create for the municipalities to raise local revenues. Inthis regard, the transfer o f royalties could be made conditional upon the municipalitiesmeeting certain financial management standards andspecified targets for property tax collections. xxix. Also, a vision could be developed for municipal tax policy. With the advent o f a more significant property tax, it would make sense to eliminate many o f the local "nuisance" taxes currently collected at the municipal level and concentrate tax collection efforts on a few major items, such as property, vehicles andperhaps commercial / professional licenses. xxx. Finally, a reflection on the linkages between a more effective landtax policy and the existingprogram o fagrarianreform. While a significant landtax should leadto some redistribution o f land to more productive and well capitalized medium and smaller farms, it will not directly put more land into the hands o fthe rural poor. It will however make more landavailable to the market and, as such, should leadto lower landprices. The land tax should thus lower the cost o f purchasing land for agrarian reform and increase the number o flandless that the governmentcould settle innewcolonies for the same amount o f budget. vii xxxi. A significant landtax would also act to address some ofthe injustices o fthe former program o f agrarian reform which distributed large amounts of land to relatively few people. Tryingto recover these "ill-gained lands" (tierras malhabidas)would be a long, costly and contentious legal process. Instead, society could recover some o f the economic rent from these landsvia an effective landtax and use the proceeds to finance social services and infrastructure inthe rural areas. An effective land tax would thus provide some "social justice" to the excesses o f the past. xxxii. To conclude, it is noteworthy that some countries have faced similar land distribution problems as does Paraguay today and are addressing these problems via a land tax. Namibia's newly created landtax, for example, incorporates many o f the same principles and features as recommended inthis report, e.g., the use o f self-assessments, market values and a similar tax rate. It i s also based on the same economic principles discussed inthis report, namely, the stimulative effect o f the tax on production and the moderating effect o f the tax on landprices. Namibia mobilized a national political consensus to create and implement a new landtax, which shows that such changes in national landtax policies are feasible ina developing country context. ... V l l l Chapter I:Land Issues and Property Taxation in ParaguayToday ExistingPatternsof Land Ownership 1.1 Paraguay has one o f the world's most skewedpatterns o f land ownership -- 2 percent o f the agricultural establishments (about 6,400 farms) occupy 82 percent o f the agriculturally exploited land(about 20 million hectares, or one-half o f Paraguay's total area o f 40 million hectares).2 Statisticalmeasures of distribution are subject to debate because o f the large holdings inthe arid Chaco (two-thirds o f the country but with only 2 percent o fthe population). Nevertheless, the inequality o f landownership is evident and has become a major cause o f rural social unrest and a brake on pro-poor growth. Table 1.1:Number and Area of Farms in Paraguay, by Farm Size, 1991 I Eastern Region Western Region Paraguay (Chaco) Total Number of Area Number of Area Number of Area Farm Size Farms (hectares) Farms (hectares) Farms (hectares) Small 254,170 1,462,573 2,402 57,572 256,572 1,520,145 Medium 41,485 1,758,552 2,770 902,727 44,255 2,661,279 Large 4,868 8,207,625 1,526 11,428,692 6,394 19,636,317 Total 300,523 11,428,750 6,698 12,388,991 307,221 23,817,741 _________________________. .----inpercent (%) ------. ._____________________ Small 85 13 36 0.5 84 6 Medium 14 15 41 7 14 11 Large 2 72 23 92 2 82 Definitions Hectares Average Hectares Average Average Small upto 20 6 upto 100 24 combined 6 Medium 20 -300 42 100- 1500 326 '< 60 Large >300 1686 >1500 7489 " 3071 91 (the latestwith complete coverageof the country) and staff estimates. See Appendix Table 1 for greater detail. Definitions of farm group size accordingto the recent agriculturalincome tax, Ley de Impuesto a las Rentas de las Actividades Agropecuarias (1magro)-- Box 1.3. 1.2 The existing pattern o f land ownership has its roots inhistorical factors. Following the War o f the Triple Alliance (1865-1870), the Government opened vast tracts o f land to foreign investors as part o f an effort to attract people and capital to re- populate the country inthe wake o f the loss o f almost the entire male population. Many large holdings, some inexcess o f one million hectares were established at that time, both inthe Easternregionfor cattle ranchingand forest exploitation as well as inthe unpopulatedChaco, inparticular, along the banks o fthe Paraguay river for exploitation The Gini Index of land concentrationwas calculatedby F A 0 at 0.93 for Paraguay, the highest inthe world, versus indices of 0.8-0.85 for other countriesinLatinAmerica (e.g., 0.85 for Brazil, 0.79 for Colombia) and indices of 0.5-0.6 for Asia (e.g., 0.55 for Philippines, 0.58 for India, and 0.61 for Turkey). Paraguay has 5.8 millionpeople, of which 2.5 million live inthe rural areas. In2005, overall poverty was estimatedat 38 percent and rural poverty at 37 percent. 1 o f quebracho wood for its tannin, which was exported downriver to the leather curing industriesinArgentina. 1.3 Duringthe second halfofthe 20thcentury, Paraguay implemented aprogram of "agrarian reform" which distributed landto existing and potential farmers, but also contributedto the skewed patterns o f landownership noted above. The program distributedabout 12millionhectares o f land, but 74 percent o f it went to only 2.5 percent o fthe beneficiaries (Box 1.1). Some o f these lands are considered to be "ill-gotten" (tierras malhabidas), since they were awarded to friends o f the Stroessner regime (1954- 89) as favors for political, military or civil service, but without any clear linkage to the agricultural "aptitudes" o f the beneficiaries, as called for inthe law. As such, many o f the beneficiaries o fthe agrarian "reform" were not necessarily adept at usingthese lands ina sustainable or economic fashion, withthe resultthat largeareas ofParaguay are currently perceived to be "unproductive" Zatijiundio or underutilized land. Box 1.1: Fifty Years of Agrarian Reform, 1950-2000 Law 854 of 1963 (Que Establece el EstatutoAgrario) establishedthe Agrarian Reform andprovided for the distribution of government land.topersons who were inpossessionof andpeacefully cultivating the land, andto those who wished to farm basedon their merits, e.g., numberof family, agricultural aptitudes, being a veteranofthe Chaco War or a "repatriated" person, and level of education (Art.79). The law's aim was to incorporate the campesino population inthe economic and social development of the country via a "just distribution" of land (Art.2) and aprocessof colonization with the objective of "populatingthe interior of the country" (Art.38). As such, it set generous maximum limitson landper beneficiary: 100 hectares for farming (inboththe Easternand Westernregions), and 1,500 has. for ranching inthe EasternRegion and 8,000 has. for ranching inthe Chaco. The law was implementedby the InstituteofRural Welfare (Instituto de Bienestar Rural -IBR). According to arecent study basedon IBRrecords,* the program distributed 11.88 millionhectares of land (about 29 percent of Paraguay's total land area), but inahighly unequal pattern. About four thousand persons(or 2.5 percent ofthe total beneficiaries) received 8.8 millionhectares (or 74 percent ofthe total land distributed) - see the combined "greater than" categories inthe following table. Beneficiaries Has. Average (has.) Eastern Region 159,814 4,179,187 less than 100 has 157,313 2,710,543 17 greaterthan 100has. 2,501 1,468,644 587 Chaco 4,736 7,704,O75 less than 1,000 has 3,154 346,143 110 greaterthan 1,000 has. 1,585 7,357,932 4,642 Paraguay, Total 164,550 11,883,262 combined ``=eater than" 4.086 8.826.576 Ofthe total, the study identified about 1.5 millionhectaresthat hadbeendistributedinexcess of the stipulatedlimitsandor inmore than one lot to the same person. The study called for the investigation of these `ill-gotten lands ("tierras malhabidas") and for their returnto the State for re-distribution to legitimate beneficiaries. * "Distribucidn de la tierra en el Paraguay destinadaa la reforma agrariaperiodo 1950-2000" (mimeo, not published)by Diputado EfrainAlegre Sasiain, Asuncion, November 2004. 2 1.4 The agrarian reform nevertheless also benefited landless rural poor -the above study indicates that about 160,000 families were settled on 3 million hectares duringthe second half of the 20thcentury. An official report by IBR3states that it established 957 "colonies" and distributed lots to 134,300 families between 1963 and 2001. It notes that the rhythmo fcolonization increased dramatically followingthe overthrow o fthe Stroessner regime in 1989, with nearly one-half o f the above lots distributedbetween 1990 and 2001.4 1.5 These new colonies were mainly established inthe eastern andnorthern departments o f the EasternRegion (Canindeyii, San Pedro, Caaguazu, Alto Parana, Concepcih and Itapua) which were those with the greatest areas o f "unproductive" forest^.^ The choice o f these areas reflects the tendency o f rural migration duringthe 1990s, as well as the preference for forested lands by the landless who often invaded these lands, demanded expropriation and subsequently deforested much o f their properties.6 As a preventative measure, many landowners purposefully cut their forests to make their lands less attractive to invasion. Inretrospect, the agrarian reform law, which defined forests as "unproductive" landto be cleared and put into production, together with the authorities' willingness to expropriate landthat had already been invaded, contributed to the deforestation ofthe EasternRegion, which today retains only about 5 percent o f its original forest cover (BosqueAtldntico). 1.6 An important finding ofthe IBRCensus o f2001 was that only 5 percent o fthe censused families7had title to their properties. The report attributes this low level o f titling to the fact that most o fthe censused families had only recently been settled and hadnot yet paid for their properties -the law required that the beneficiaries pay the full fiscal value o ftheir properties before receiving title andprovided for a ten year period to makepayment. The report notedthe precariousness ofthis situation andthe desirability o f having clear title for purposes o f obtaining credit and investing inthe property. The Census found that 9 percent o fthe properties had already been abandoned, perhaps due to lack o f title, and viewed the problems o f titling as an important factor contributing to the abandonment o f lots and migration to the cities. 1.7 A further problem withthe agrarian reform law was its reliance on expropriation without clear rules for com ensation. Several large propertieswere expropriated during the 1990s and early 2000s, but compensation has not been paid, leaving these properties P unusable to the former owners but yet unavailable for formal resettlement. Meanwhile, 31nstitutode Bienestar Rural, "Censo de Colonias2001, Informe Final", Asuncibn, Julio de 2002. 4The distribution of these lots didnot necessarilylessen the concentration of land ownership from that as portrayed inTable 1, since many smallholders sold or leasedtheir lots to mediumand large scale soy producing farms duringthe during 1990s(L`lafamosa ventade las derecheras," Ibid.page 27). Ibid., page 11, "mayor superficie de tierras boscosas improductivas". The Census argues, however, that the settlers are not "depredadores" o ftheir lands and"still conserve an important area (39 percent) as forest," Ibid. pages 14 and 28. 7Ibid. The Census covered 35,576 families in229 colonies. The average property was 10 hectares, with 55 percentof the properties inthe 5 to 10hectare range. 8 For example, the 130,000 hectareAntebi property inConcepcih. 3 they are being occupied informally inanunplanned manner with unsustainable practices, e.g. indiscriminate deforestation. 1.8 A new agrarian reform lawwas passedin2002 to address some o fthe above problem^.^ The new law reaffirms the State's guarantee o fprivate property for rural land (Art.1) andexpressly prohibits the expropriationofproperty that has been invaded or illegitimately occupied (Art. 98). It nevertheless provides for the possible expropriation (Art.94) o f "unproductive lands" (latifundio improductivo) and lands that are not "rationally utilized," which are defined as those that exploit less than 30 percent o f their agriculturally useful area inan economically and environmentally sustainable manner. Rules for compensation are now clearer with definedtimelines for payment. Unproductive latifundios will be compensated at their fiscal value, while other lands and improvements will be compensated at their fair market value. 1.9 Importantly, the new law recognizes the environmental value o f natural forests and excludes them, as well as requiredforest reserves, wetlands and wild areas from the calculation o f agriculturally useable land. The new law thus eliminates the previous law's bias against forests as unproductive, and thus suitable for expropriation, and the incentives for owners to cut down forests inorder to avoid invasions. 1.10 The newlaw reduces the amount o f landthat can be distributedper family for farmingto a maximumo f 30 hectares o f agriculturally usable land, but still maintains a generous allocation for cattle ranching, up to 4,000 hectares, but now only inthe Chaco Region. The law facilitates the transfer o f title by permitting that title can now be transferred once the beneficiary has paid25 percent o fthe fiscal value o f the land, instead o fthe full amount. A 30 percent discount i s available for those who pay the full price up- front, rather than in 10 annual installments. Assessment 1.11 The historical policies o flanddistribution aimed at populating Paraguay rather than creating an optimal distribution o f what has become a scarce natural resource (agricultural land). The process resulted inhighland concentration, sub-optimal productivity (see Chapter 3), social conflict characterized by invasion and expropriation, and embedded situations o f rural poverty.loFurther agrarian reform is now severely limitedbythe lack o f government lands(tierrasJiscales)available for distribution, Ley 1863/02que Establece el EstatutoAgrario andLey 2002/02 which made some further modifications. lo While agrarian reform established a large number o fpeasantcommunities, a deeper problem has emerged as these communities fail to take root due to the poor quality of agricultural extension services, the lack o f social services andrural infrastructure, and the migration o f individuals to the urban periphery. A model o f agrarian capitalism has contributed to this trend inwhich the soybean industry has spread far into Paraguay from Brazil, with growers purchasing or leasing landto feed global demand (soy production currently occupies about 2 million hectares inthe Eastern Region). The resulting stagnation and displacement o f smallholders has contributed to the continuing high incidence o frural poverty (over 50 percent). Also, the lands o f indigenous peoples have been increasingly vulnerable to the expansion o f soy farming and cattle ranching, leading to a series o f conflicts andprotests. 4 particularly inthe EasternRegion, and the lack o f financial resources to purchase land from willing sellers. 1.12 A more comprehensive approach to landissues is neededto create a vibrant rural land market that would work infavor o f reducing rural poverty while fostering agricultural productivity and maintaining the natural resource base. This study focuses on one, but a crucial, element o f landpolicy, namely, land taxation, with the view that a correctly structured land tax would provide an economic incentive for land owners to use their landmore productively, and/or to sell or rent their underutilized landto farmers who can. Existing Property Tax (ImpuestoInmobiliario, Ley 125/91) 1.13 Realproperty taxation has long existed inParaguay, but as inother countries in Latin America, its importance declined duringthe second half o f the 20thcentury with the advent o f value added and income taxation. Real property taxes accounted for 12percent o ftax revenues inthe 1940s," but currently represent only 3.2 percent o f total tax revenues and 0.4 percent o f GDP. Property taxes nevertheless account for about one-half o f municipal tax revenue (see next section andAnnex Table A3.5). 1.14 Property taxes (el impuesto inmobiliario) were previously administered by the central government, but the Constitution o f 1992 transferred the collection and use o f property taxes to the municipal governments as an autonomous source o f revenue. According to the Constitution, 70 percent o f property tax revenue is to be retainedby the municipality o f origin, 15 percent transferred to the respective departmental government (Gobernacidn), and 15 percent to the central administration for re-distributionto the poorest municipalities. Despite local administration and collection, l2the property tax remains governed by national tax legislation (Ley 125/91). Also, assessedvalues for the tax (valoresfiscales) are set by the National Cadastre Service (Servicio Nacional de Catastro), rather thanthe municipality. 1.15 The property tax applies to bothrural and urban properties, andhence covers all landinParag~ay.'~ Urbanproperties are taxed on the value o flandplus improvements (buildings), while rural properties are taxed only onthe site value o f land (excluding improvements) so as not to discourage investment. Inprinciple, it would be beneficial to extend this same principle of not taxing improvements to urbanproperties, but this i s a subject that requires additional analysis beyond scope o f this report. 1.16 A basic tax rate o f 1percent applies to all property, including improvements in the urbanareas. The rate is reduced to 0.5 percent for ruralproperties less than5 hectares. An additional rate, ranging from 0.5 to 1.O percent, i s applied to large rural l1 Skinner (1991a) "Prospectsfor agricultural landtaxation indeveloping countries," page495. l 2The municipalities are responsible for maintaining a fiscal cadastre -- basically a list of propertieswith a cuentacorriente for urban properties and apadrdn andJinca number for rural properties. l3 Most municipalities comprise an urban center andthe surroundingrural lands, except e.g., the capital, Asuncion, which i s all urban. 5 properties (inrnuebles de gran extensidn), namely, those larger than 10,000 hectares inthe Eastern Region and larger than 20,000 hectares inthe Chaco. The highest additional rate applies to properties o f more than 30,000 hectares inthe Eastern Region and more than 60,000 hectares inthe Chaco. For "Zatifundios" (not defined inthe law, but presumably larger than the largest category inthe precedingpoint), an additional charge o f one-half o fthe preceding additional rate i s supposed to be added. Maximumtax rates could thus reach 2.5 percent for Zatifundios. 1.17 The law provides for a number o f exemptions, including: 0 Fiveyears for lands "colonized" as partofthe agrarian reform, startingfrom the date when the lands are formally transferred with title. Giventhe long delays in the transfer o ftitle mentioned above (only 5 percent of settlers holdtitle), these lands are, inpractice, not subject to the propertytax; 0 Indigenous lands; 0 National parks and reserves, but not privately heldnatural forests or wetlands; 0 Lands heldby Chaco War veterans or their widows; 0 Properties heldby political parties, unions, educational, religious, cultural and civic institutions, and sport clubs; 0 Government properties (military, schools, hospitals, etc.) and foreign government- owned properties, etc.; 0 Reductions o f up to 50 percent inthe event o f verifiable natural calamities. 1.18 While some features o fthe property tax law are subject to comment and debate, e.g., exemptions for private sports clubs and political parties, and multipletax rates which create distortionary incentives for artificial sub-division o f land to avoid higher rates,14 the principal anomaly of the existinglaw is that the assessed value for tax (valor fiscal) is far below the market value of the properties. Data presented inChapter 2 for the Departmento f Caaguaz6 indicatethat the fiscal values o fruralpropertiesaverage only 2 percent o f their market values and insome areas are as low as 1percent o f the market value. A similar undervaluation o f fiscal values i s believed to exist inthe other rural areas o f Paraguay. 1-19 As a result o fthese extremely low fiscal values,I5 the property tax inParaguay raises only limitedamounts o f revenue, mostly from urbanproperties.16 Dueto the low fiscal value o f rural land, a deficit inlocal administrative staff, rudimentary collection procedures, and the relatively higher cost o f collecting the tax on disperse rural properties l4Annex 1presents the existing property tax law, Ley 125/91, along with annotated comments. l5Chapter 4 provides an overview o f fiscal and market values for other Latin American and OECD countries. l6The datapresented inChapter 2 suggestthat for municipalities inthe interior, about 80 percent of actual collections originate fiom urban properties and only 20 percent from rural properties. 6 versus properties inthe urbanarea (casco urbano), municipalities often find it not worthwhile to collect the tax on rural properties. This tendency is reinforced by the absence o f effective penalties for not paying the tax. Law 125/91 does not explicitly provide fines for delay inthe payment o fthe property tax, or for seizure and sale o f the property following several years o f delinquency inthe payment o f tax. Inpractice, for rural land, the tax is often paid only when the land i s sold or m~rtgaged.'~ 1.20 The law stipulates that fiscal values shouldbe adjusted annually ina gradual manner to reach market values (valor real de rnercado),but the annual adjustment should be no higher than consumer inflation inthe precedingyear and, inany case, not more than 15 percent. In effect, the law guarantees a permanent situation of under- valuation of property values. 1.21 The following table shows the annual increases infiscal values that were approved following enactment o f Ley 125/91, compared with inflation inthe respective previous year." Aside from a significant increase infiscal values that was applicable to 1993 (inapparent contradiction to the inflation caps contained inthe law), the subsequent increases were all relatively minor, or even negative, when adjusted for inflation and viewed inreal terms. Table 1.2: Increasein FiscalValues vs. Inflation in Previous Year, 1993-2006 (in percent, YO) 1/ Annual ExecutiveDecrees. ServicioNacional de Cafastro. 21 ConsumerInflation Index,Banco Centraldel Paraguay. 3/ The change in real terms is calculatedby dividing the index of the change infiscal values by the index ofthe change in inflation and is thereforedifferent thanthe simple "difference" shown inthe third column. 17No property may be legally transferredor mortgagedby an escribanopliblico without the tax being paid up-to-date. '*The annual increase in fiscal values is basedon recommendationsby the SNC and authorizedvia ExecutiveDecrees that are normally issued inDecember of each year and establishfiscal values for the following calendar year. 7 1.22 The cumulative effect of the increase infiscal values from 1993 through 2006 can be seen inthe following chart (Figure 1.2). While fiscal values have risen by a factor of five (with an index value o f 555 on the chart) mainly due to the large increase in 1993, inflationhas also been considerable duringthis period, having risen by a factor o f four (to an index value o f 429 on the chart). The resulting increase infiscal values inreal terms has thus been very modest -- 29 percent (an index value o f 129 on the chart) -- over a fourteen year period. Ina sense, the increases have complied with the technicalities o f the law-to increase fiscal values towards marketvalues "gradually" while not exceeding annual inflation inthe process -butthe increase has been so gradual that fiscal values are unlikelyto ever approach the law's stated objective o fachieving market values. Figure 1.1: CumulativeIncrease in FiscalValues vs. Inflation (1992 = 100) 600 1 .. 0 I Inflacibn- - - -Valor Fiscal -V. F.en tCrminos reales 1.23 The annual revaluations infiscal values also reflect the politically sensitive nature o f increasing property taxes. Table 1.3 shows the increases that occurred during successive periods o f government. The large increase for 1993 was decreed duringthe last year o fthe transition military government. Duringthe following two administrations (1994-98 and 1999-2003), the average increases were negative inreal terms. Increases duringthe current administration have been only slightly positive inreal terms. Table 1.3: Increase in FiscalValues in RealTerms (YO) Cumulative Average per for Period Annum -10.8 -2.2 29.3 2.1 8 1.24 The second important characteristic o f fiscal values duringthe past fourteen years i s that the increases have been applied uniformly throughout the country, both for rural and urban properties,without regard to changes in relative property values. Annex 2 documents this practice. It shows the fiscal values for rural landby department and district for all municipalities inParaguay (Annex Table A2.1). Each departmenthas several fiscal values for rural landthat were set in 1992 (for example, there are currently six values that apply to the 20 districts inthe Department o f Caaguazu). These values have remained the same inrelative terms since 1992, namely, they have all been increased by the exact same percentage each year. These percentage increases can be seen inAnnex Table A2.2. As can be seenby simple eyeball inspection, the same percentage increases have been applied to all districts inParaguay, as well as to urban landand improvements (Annex Table A2.3). 1.25 The practice o f applyinguniform increases infiscal values to all properties in Paraguay reflects the limitedassessment capacity at boththe national (SNC) and municipal level. This is understandable giventhe large number o f properties in Paraguay, but the practice ignores real changes inthe market value o f land, for example, the significant increase inthe value oflandsuitable for soybean production. As documented inChapter 2, this uniformrevaluation process has createdwide discrepanciesinthe relationship of the fiscal to marketvalue of land, leadingto an inequitable distribution o f the property tax burden, even as the fiscal values o f all land remain significantly below market values. Recent Attempt at Reform 1.26 Inresponse to increasingincidentsofrural invasions andwith aview tojump- startinga ruralpoverty reduction program, the current administration sent a draft law, Tax on Rural Wealth (Impuesto al Patrimonio Rural), to Congress inOctober 2004. The proposal contained several forward-looking and desirable features from a landtaxation policy point o f view, such as the use o f market values instead o f fiscal values as the base for tax assessment, the use of self-declarations to overcome the limitedcapacity o fthe SNC and/or the municipalities to carry-out market based assessments, the publication of self-assessments as a means to ensure transparency and civic control, and the creation o f adjustment and appeal mechanisms to ensure consistency and fairness inthe self- declaration process. These features are presented inmore detail inBox 1.2. 1.27 The proposal nevertheless contained a number o fproblematic features, in particular, it was proposed as a temDorary tax to finance poverty reduction programs until 2015. Ingeneral, it is undesirable to create a newtax structure for a limitedperiod which leads to redundant bureaucratic systems and creates incentives for tax evasion. Second, it proposed to channel the revenues to the central administration, instead o f usingthem at the local level wherethere is greatest identificationbetweentax payers andthe expenditures financed with the tax. Third, it proposed to suspend the existing:property (impuesto inmobiliario) during this period, without regard to the loss of revenues this would entail for the municipalities or for the dismemberment o f their existing, albeit limited capacity for administering the property tax as it is today. Fourth, it proposedto 9 tax improvements and farm machinery, which would act as a strong disincentive on new investment inagriculture. Finally, it maintained the "progressive" structure of property tax ratesthat leadsto artificial and perhaps uneconomic sub-divisions of rural properties. Box 1.2: Proposed Tax on RuralWealth (Patrimonio Rural) The Executivesent a draft law, "Impuestoa1Patrimonio Rural, to the Congress on October 1,2004. It proposedto create a new tax on ruralwealth (land, improvementsand machinery dedicatedto agricultural production,hence, `)atrimonio") for the purposeof financing a national poverty reduction program. The principal features ofthe proposedtax were: It would be temporary, for 11years through 2015, to coincide with achievementofthe millennium developmentgoals (MDGs). The existing impuesto inmobilario would be suspended during the period of the new tax. It would be based on the market value ofrural properties(vs. the fiscal values usedfor the impuesto inmobilario) plus the value of the improvements(mejoras) associatedwith the land. Propertyowners would be requiredto make a self-declaration(declaracidnjurada) ofthe market value oftheir properties. The value ofproperty inall legal documents concerning its sale and mortgaging would be limited to the average declaredvalue ofthe previoustwo years. This value would be used in the event ofexpropriation. The ServicioNacional de Catastro would publish the self-declarations, by municipality, and would be empowered to adjust the declaredvalues basedon knowledge of current markettransactions. A three personreview committee(Junta deAvallio), comprisingrepresentativesfkom the businesshancher sector, campesino organizations and the Ministryof Finance (Hacienda), would be created to receive protestsand settle valuation disputes. Holdings of less than 20 hectares inthe EasternRegion and 100hectares inthe Chaco would be exempt. The tax rate would rise from 1percent on lands less than 1000hectares to 2 percent on holdings more than 30,000 has. For the purposeof applying the rate, property owners would be required to make a combineddeclarationof all their holdings, including propertiesinthe name of immediate family members. The tax would be administeredby the Ministryof Finance, which would be empoweredto make collection-agentagreements with the municipalities and departmentalgovernments, which would retain up to 10 percentand 5 percent, respectively,of the revenues they collect. The revenues would be usedexclusively to finance the Social Equity Fund(Fondo de Equidad Social), which was being createdat the time to administer the national poverty reduction program. The Fund would have discretion to use the revenues for the purchase of land for new campesino settlements, healthand educationprograms inthe rural areas, programs of conditional cash transfer to targeted poor, and other programsdesignedto meet the MDGs inthe rural areas. 1.28 Inthe event, Congresshasnot actedonthe proposal, whichhaslaindormant since it was submittedin2004. Inpart, this was dueto the fact that Congresshad approved a contentious tax reform law inearly 2004, including a new agricultural incometax (see Box 1.3), and didn't want to reopen a debatethat would affect the agricultural sector. Coincidently, the rural sector was protesting recent increasesinthe diesel fuel tax, and a 10 proposed tax on the export o f soybean hadjust been proposedwith the aim o f stimulating the localprocessing of soy, 70 percent o fwhich is exported inan unprocessed state. 1.29 Evenwithout the unfavorable accompanyingcircumstances, the proposedtax would have been politically contentious, since it goes inthe opposite direction o f creating a viable source o f revenues for local governments and promoting decentralization. Also, the proposed law did not provide exemptions for natural forests or wetlands, without which it would increase the incentives for further deforestation. The proposal nevertheless plants some interesting ideas for future debate on how to improve the existingproperty tax. Overview of Municipal Finances 1.30 Consolidated data on municipal finances does not exist inParag~ay.'~ Ever since the municipalities were given autonomous status by the Constitution of 1992, their budgets are approved by their respective municipal councils without reference to the central administration. Inprinciple, they are required to submit their final annual accounts to the Auditor General andthe Ministry o f Finance, but compliance i s spotty andwith delays. 1.31 A study by JICA compiled data onthe finances o f 58 o fthe 222 municipalities of the interior (excluding Asunci6n) for 1999-2003.20 This sample includedmunicipalities from the four groups o f municipalities that correspond to their relative size, with Group 1 representing the Head o f Department (cabeceradepartamental)plus a few other larger towns and the other groups descending in size to the smallest rural municipalities. The distribution o fthe JICA sample, as well as the distribution o f the municipalities not includedinthe sample i s shown inthe following chart. Included inJICA Sample Not Included Numberof Population Number of Population Municipalities (2002) Municipalities (2002) Group 1 14 1,682,629 8 496,783 Group 2 26 628,340 45 952,659 Group 3 14 157,900 98 1,029,136 Group 4 4 28,203 13 86,7 16 Total 58 2,497,072 164 2,565,294 1.32 Consolidated data for the 58 municipalities included inthe JICA sample is presented inAnnex Table A3.1. It shows that this group o f municipalities have total revenues equivalent to about 0.5 percent o f GDP. Ofthis amount, property tax revenues are equivalent to 0.13 percent o f GDP and represent about one-quarter o f total revenues and about one-half o ftax revenues. Commercial andvehicle licenses are the other main sources of tax revenue, while non-tax revenuecomprises mainly fees for garbage 19 The Ministry of Financerecently compiled suchdata for the fnst time (Informe Financiero, 2005), but it *'i s limited in scope, e.g., does not provide details on property taxes nor include all municipalities. JICA-MH-COPLANEA, Municipalidades de la Regi6n Oriental del Paraguay, 2004. 11 collection, public lighting, parking and rental o f public spaces. O f note, royalties from the Itaipuand Yacyreta hydroelectric dams increasedrapidly from zero in 1999 to 18 percent o f total revenues in2002 and2003.21 1.33 To gain an overall picture o f municipalfinances inParaguay, an extrapolation o f the JICA sample was made for the other 164 municipalities o fthe interior, basedon the relative population o f each group.22 The results for these 164 municipalities, which are dominated by Group 3 municipalities, are presented inAnnex Table A3.2. They show similar patterns o f revenue and expenditure as the sample o f 58, but at slightly lower absolute levels, Le., these 164 municipalities have total revenues o f about 0.45 percent o f GDP, and the property tax share is closer to 20 percent o f total revenues reflecting more difficult and less systematic tax collection practices inthe more rural areas. (See Annex 4 for a discussion o f municipal tax administration and financial management issues.) For these smaller municipalities, royalties represent a larger share o f total revenues (about 30 percent) than inthe sample o f 58. 1.34 Data for all 222 municipalities o f the interior i s combined inAnnex Table A3.3. The composition o frevenues for these municipalities inshown inFigure 1.2. Figure 1.2: Compositionof Municipal Revenuesfor 222 Municipalities of the Interior, 2003 (Percent of Total Revenues) Capital Roperty Taxes Revenues 5 -- 77 ther Tax Revenues23 Revenues27 . ._.-. --- -. . 1.35 Itis interestingto note from the data inAnnex Table A3.3 that actual collections of the additional tax on large properties (adicional a inmuebles de gran extensidn y 21 Royalties are received by the central administration and distributed to the municipalities and departmental governments based on a formula that takes account o f the relative impact o f the dams on the communities, but all municipalities receive some royalties. The sharing o f royalties with the municipalities and departments started in2000 and is supposed to rise to a target o f 50 percent by 2010. 22 Projection by group was done inorder to preserve differences inthe revenue and expenditure structures o f the four groups. An alternative projection was also made based on the number o f municipalities in each group, but this produced a larger estimate o f revenue and was discarded infavor o f the more conservative results based on relative population size. See Annex 3, page 4 for details. 12 latifundios) specified inLey 125/91(see para.1.16) is only 1 percent o f total property tax collections. This fact reinforces several previous points, namely that collections from rural properties are estimated to be only a small fraction o ftotal property tax collections (around 20 percent) and that enforcement o fthe actual property tax law is uneven at best with little attentionpaidto collecting the "additional" tax. 1.36 Data was also collected independentlyfor Asuncih, which i s presented inAnnex Table A3.4. Two significant differences mark the structure and pattern o f Asuncih's revenues compared with the municipalities of the interior. First, property taxes are a more important share o f total revenues inAsunci6n (34 percent) than for the municipalities o f the interior (22 percent), inpart because Asuncion receives a relatively small amount o f royalties amounting to only 2-3 percent o f revenues. Table 1.4 illustrates this difference inthe structure o f revenues. Table 1.4: Composition of Municipal Revenues,2003 (as percentof Total Revenues) Asunci6n Interior All Tax Revenues 66 49 55 Property Taxes 34 22 26 Other Tax Revenues 32 27 29 Non-Tax Revenues 31 23 26 Royalties 2 23 15 Capital Revenues 1 5 4 Total 100 100 100 1.37 Second, for reasons not readily apparent, total revenues inAsuncion declined significantly as a share o f GDP, from 0.68 percent in2001 to 0.5 percent in2003 and 2004 (see Appendix Table 2). As a result, Asuncion began to re ister slight overall deficits, on average about four percent o f revenues, in2002-04?' Such deterioration did not occur inthe municipalities o f the interior, which experiencedan increase inoverall revenues duringthis period as a result o f rising royalty income and increasing property taxes. The municipalities o f the interior maintained slight overall surpluses, inthe range o f 5 to 10 percent o f revenues, duringthis period. 1.38 One factor that may have contributed to the decline inAsuncion's revenue performance was that the fiscal values for property taxation were not increased at all in 2003 and by only 3 percent in2004, far less than the combined 24 percent inflation for these two years (see Table 1.2). The erosion o f fiscal values inreal terms was thus about 20 percent, equivalent to the percentage decline inAsuncion's property tax collections which fell from 0.18 percent o f GDP in2002 to 0.17 percent in2003 and 0.15 percent in 23 The measurement of deficits for the municipalities is problematic due to inconsistent financial accounting practices that, for example, treat cashbalances from the previous year as income inthe following period. Also, interest and amortization are lumpedtogether as an expense, rather thantreating amortization as a below-the-line financing item. Adjustments to reclassify municipal accounts accordingto public finance standardshave been made, to the extent possible, to the data inAnnex Tables A3.1-A3.5. 13 2004. The same erosion o f fiscal values applied to the municipalities o fthe interior, but incontrast to Asuncibn, they actually improvedtheir property tax collections from 0.2 percent o f GDP in2001 to 0.22 percent in2003.24 1.39 Key revenue statistics for the municipalities as a whole (Asunci6n plus Interior) are summarized inTable 1.5. Table 1.5: Key Revenue Statistics for All Municipalities (Asunci6n +Interior), 1999- 2003 --______________2001 1999 2000 2002 2003 as percent (%) o f GDP ----------------- Total revenues 1.45 1.55 1.63 1.60 1.49 olw Interior 0.81 0.87 0.94 1.02 0.98 Tax revenues 0.87 0.90 0.87 0.84 0.82 olw Interior 0.51 0.51 0.49 0.49 0.48 Property taxes 0.36 0.39 0.40 0.39 , 0.39 olw Interior 0.19 0.20 0.21 0.2 1 0.22 Royalties 0.0 0.05 0.18 0.25 0.23 olw Interior _-___________--_____--("%). .0.25. . . . . . . . . . . .0.22. 0.0 0.05 0.18 as percent . . . . . . Property tax I revenues 25 25 24 25 26 Royalties I revenues 0 4 11 16 15 See Appendix Table 2 for detailson Asuncion. Also, Annex Table A3.5 for underlying numbersandother ratios. Annex Table A3.5 consolidatesthe financialdatafor the three sets of municipalities, Le., actual datafor the 58 municipalities of the JICA sample, estimatesfor the 164municipalities not includedinthe JICA sample, and actual datafor Asuncih. 1.40 Together, the municipalities hadtotal revenues in2003 equivalent to about 1.5 percent o f GDP, o f which the municipalities o f the interior represent about two-thirds, or about 1 percent of GDP. Within total revenues, tax revenue performance appears to have weakened since 2000, especially inAsunci6n but also somewhat inthe interior. Property tax collection, however, remained constant, both as a percent o f GDP (0.39 percent) and as a share o f total revenues (about 25 percent). Improved property tax performance inthe interior compensated for weakening performance inAsunci6n. 1.41 Royalties have become increasingly important to the municipalities o f the interior since 2000, when the central government beganto share royalties with the municipalities and departmental governments. This trend i s expected to continue through 2010, when the municipalities and departments are supposed to receive fully 50 percent ofthe royalties received by the central g ~ v e r n m e n t .In ~ ~2003, the municipalities received royalties equivalent to about 0.2 percent of GDP. This was, however, only 5 percent o f the total royalties received bythe central government, which were equivalent to 4.2 percent o f GDP (see Table 1.6). 24Perhaps because some o fthese municipalities participated ina USAID project to improve property tax collections intheir urban areas (see Annex 4). Data for municipalities of interior are not available for 2004. 25Tenpercent for the Departments and 40 percentfor the Municipalities, per Ley 1309/98. See Annex 4 for a more detailed description o froyalty sharing. 14 1.42 Ifroyalty flows to the centralgovernment remainattheir current levels (about 4 percent o f GDP), and ifthe sharing o f royalties with the municipalities reaches the specified level o f 40 percent, thereafter the municipalities could expect to receive about 1.6 percent o f GDP per annum inroyalties. This amount would be considerably more than the current level of total revenues of the municipalities of the interior (about 1 percent of GDP) and poses several major challenges: 0 A moral hazardthat with such large flows of "effortless" resources, the municipalities o f the interior would relax or even abandon their collection efforts for current tax and non-tax revenues;26 0 The need to improve financial administration to manage effectively a quantum increase inresources and expenditures; and 0 The need for better planning and implementation o f expenditures, especially capital expenditures, since Ley 1309/98stipulates that 80 percent o f royalties should be spent on capital investment. 1.43 Given the pending bonanza o f increasingroyalty income, the worst outcome would be for the municipalities to substitute royalties for existing "genuine" sources o f revenue, thus weakening their hard-won local revenuecollection efforts. A better outcome would be for the municipalities to improve their financial administration and investmentplanningcapacities so that they can effectively apply increased royalties to productive public investments inthe rural areas, for example, rural road maintenance, newhealthand educationfacilities, etc. Such an effort to improve financial administration and investmentplanning capacity could perhaps be assisted by the MinistryofFinanceinthe form o fa nation-wide programto standardize municipal accountingpractices, upgrade financial administration systems and provide best-practice advice about investment planning, monitoring and execution. 1.44 An ideal outcome would bethat inaddition to improving financial administration capacity, the municipalities would matchthe increase inroyalty income with increases in locally generated revenues, inorder to raise the overall level o f municipal expenditure to levels that could finance a more ambitious decentralization o fpublic services, including security and some health and educationrecurrent expenditures. This report argues that the property tax isthe preferableinstrumentto raise resources at the local level due to its stimulative effects on production andthe desirable synergy it creates betweenproperty taxpayers and the control over local expenditures. 1.45 Chapter 2 estimates that the property tax, ifapplied at market values, could raise about one percent o f GDP inrevenues inthe rural areas alone. Together with their existing level o f revenues (about one percent o f GDP) andthe expected increase in 26Data on municipal finances for 2005 from the Ministry o f Finance (Informe Financiero, 2005), which is not necessarilyconsistent with the above compiled data for 1999-2003, indicatesthat this phenonomenmay be occurring. Tax collections by the municipalities ofthe interior fell from 0.48 percent of GDP in2003 to 0.36 percent o f GDP in2005, while royalties receivedby the municipalities o f the interior rose from 0.22 percentof GDP to 0.49 percent of GDP over the same period. See Appendix Table 2. 15 royalties (about 1.5 percent o f GDP), the municipalities o f the interior could aim to reach a total level o f resources o f about 3.5 percent o f GDP by 2010. This level o f resources, if managed carefully, would provide a significant increase inthe ability o f the municipalities o f the interior to deliver services andimproved infrastructure to their communities andwould represent a major step towards effective fiscal decentralization. Institutional Capacity at MunicipalLevel 1.46 The municipalities' capacity for financial administrationis at a rudimentary stage inparticular inthe smaller municipalities ofthe interior (groups 3 and4). Basic shortcomings include the lack o f (or non-use of) a uniform chart o f accounts, financial planning instruments inthe preparation of revenue and expenditure estimates, cash flow control mechanisms duringthe course o fthe year, expenditure monitoring and reporting systems, low capacity for the preparationand/or analysis o f capital investment projects, and qualified accounting personnel in general. The larger municipalities are better positioned inthese areas than the smaller ones, but all municipalities are inneed o f some strengtheningo ftheir capacities. Annex 4 provides a more detailed discussion o f financial management and tax administration issues at the municipal level. 1.47 With regardto administration o fthe property tax inparticular, not all municipalities have fiscal cadastres - a basic list o f taxable properties with registered owners. O f the 58 municipalities inthe JICA sample, 52 had an urbancadastre but only 23 o f these had been updated. And o fthe 58 municipalities, only 23 had a rural cadastre, most o f which were incomplete or outdated. Muchof the information on rural properties exists only because the owners hadpaid taxes on previous occasions when they sold or mortgaged their property. Part o f the problem i s due to insufficient sharing of informationbetweenthe municipalities andthe SNC,which issues cadastral certificates for property registration. 1.48 Insome municipalities, property informationis stored on simple Excel spreadsheets, but this information i s not linked with tax collection information. Collection problems are exacerbated by the lack o f specific sanctions inthe tax law for non-payment o f property taxes, while the judicial process for claiming overdue taxes in long and costly. Late payment fees are minimal and are often waived via periodic tax holidays. A five-year statue o f limitation exists before the liability to pay the overdue tax expires. Given limited humanresources and budgets for collection, municipalities tendto focus their efforts on urban areas where notification costs are lower. Property Taxation within the Context of Paraguay's Overall Tax Structure 1.49 Paraguay's existing tax structure i s the product o f two major reforms: (i) a modern tax law that was approved in 1991 (Ley 125/91,que Establece el Nuevo Rkgimen Tributario),which introduced a value added tax, updated the excise and company profit taxes, and assigned the property tax (impuesto inmobiliario) to the municipalities; and (ii) a tax adaptation law o f 2004 (Ley 2421/04, de Reordenamiento Administrativoy de Adecuacibn Fiscal), which tightened up loopholes and exemptions under the previous 16 law for profit tax and VAT, reduced the profittax rate from 30 to 10 percent, introduced a new personal income tax o f 10 percent (to become effective in2007), and transformed the previous but ineffective presumptivetax on agricultural income (which was, in practice, a tax on the fiscal value o f rural land) into a tax on actual agricultural income that i s consistent with and complementary to the newpersonal income and company profits taxes (see Box 1.3). Box 1.3: New Agricultural Income Tax (Zmagro) The tax reformlaw of2004 replacedthe former agricultural incometax (ElImpuesto a las Actividades Agropecuarias-Imagro) with a more modemversion. The former tax was a presumptivetax on agriculturalincomethat was, ineffect, leviedon the fiscal value of ruralland. However, giventhe low fiscal values andvarious deductionsthat were allowedunderthe former tax, it was generally consideredto be a nuisance tax that was more costly inaccountingfees to file thanthe actualtax due. Indeed, the former Imagro never yielded any significant revenueto the centralgovernment. The new Imagro was designedintandem with the new personalincometax, whichis to be phasedin startingin2007 for individuals with monthly income 10or moretimes the minimumwage, with coverage to expandover sevenyears to reach eventuallyindividuals with three or more minimumwage incomes. The new Imagro taxes the income of individuals with incomefiom agriculturalactivities. Bothtaxes, however, were designedprimarilyto complementthe value addedtax andhelp formalize the economy. They bothallow the individualto deduct all expenses on whichhe has a legalreceipt andor paid VAT, includingfood, clothing, education, travel, entertainment,etc. The tax rateof 10percent is the same for bothtaxes and i s appliedto the net income after deductionof the above expenses. The new Imagro is applicableto all individuals andbusinessesthat generate agriculturalincomeon combinedpropertieslargerthan 20 hectares inthe EasternRegionand 100hectares inthe Chaco. For taxpayerswith propertiesinthe 20-300 hectarerange inthe EasternRegion(and 100-1500hectares inthe Chaco), the taxpayer can choose whether to calculatethe tax basedon actualrecordedincome, or on a proxy incomethat is relatedto the productioncoefficient that correspondsto the taxpayers district(e.g., 1500kgof soybeanat the currentyear's marketprice). Taxpayerswith properties largerthanthe above, mustcalculatethe tax basedon actual expenses andrecordedmonetaryincome. Businessescannot deduct personalexpenses, as can individuals, but can deductall normalbusinessexpenses includingwages and inputs. The newImagro enteredinto effect for the first time in2006, so it is notyet knownhow muchtax revenue it will generatedirectly, althoughit shouldincrease VAT receipts. One halfo fthe revenuesfkom the new Imagro are earmarkedby law to find the landsettlementprograms o f INDERT, includinglandpurchase,settlementandsubsequent support servicesto beneficiariesofthe agrarian reform. 1.50 As a result ofthe 2004 tax adaptation law, Paraguay's overall tax structure is relatively well balanced and neutral with regardto taxing different sources of income and consumption. Company profits, personal income, agricultural income and value added are all taxed at a uniform rate o f 10percent. Customs tariffs are governed by the common external tariff o fM e r c ~ s u rand~excise taxes are reasonable (indeed, some , ~ 27 Mercosurhas providedextensivetemporary exceptions and lower rates for Paraguay,e.g., on information technology, vehicles and"tourist" trade items(liquor, cigarettes,perfime). 17 could be higher).28 The main lacuna inthe overall tax structure i s the local property tax which, as discussed above, yields insignificant amounts o f revenuedue to the low fiscal values that are usedfor assessment. 1.51 Together, the above taxes generate about 13 percent o f GDP intax revenues, includingcentral government employee "contributions" to the government pensionfund (CajaFiscal) which the Government categorizes as non-tax revenue but are included as tax revenues inthe following table.29 Table 1.6: Evolution of Central Government Revenues, 2000 -2005 (as percent of GDP) 2000 2001 2002 2003 2004 2005 Profit tax 1.9 1.7 2.0 1.7 2.1 2.1 VAT 4.6 4.5 4.3 4.4 4.7 5.1 Excise taxes 1.8 2.2 1.8 2.0 2.4 2.2 Customstaxes 2.0 1.9 1.7 1.9 2.2 1.8 Other taxes 1/ 1.7 1.6 1.4 1.4 1.5 1.8 Total Tax Revenues 12.0 12.0 11.2 11.3 12.9 13.0 Royalties 3.2 4.9 4.3 4.2 4.0 3.6 Other Non Tax Revenues2/ 2.0 2.0 1.9 1.5 1.5 1.6 Total Revenues 17.2 18.8 17.5 17.0 18.4 18.2 11mostlycontributionsto the GovernmentPensionFund, about 1.2% of GDP. 21 includes interest received, transfers from public entities and external grants. See Appendix Table 3 for values in guaranies. 1.52 Tax revenues increased by about 1 percent of GDP in2004 and 2005 (compared to 2000-01) as a result o f improved tax administration andthe changes intax policy that were introduced by the tax adaptation law. O fparticular note is the increase incompany profit tax despite the reduction inthe profit tax rate (to a transition rate o f 20 percent in 2005). VAT collections improved significantly, reflecting greater formalization o f the economy. Excise taxes increased due to a significant increase inthe tax on diesel fuel (which was as low as 5 percent in2002). 1.53 Inadditionto tax revenues, royalties from the ItaipuandYacyretahydroelectric dams provide about 4 percent o f GDP to the central government. As previously discussed, these royalties are being increasingly sharedwith the municipalities. Figure 1.3 depicts the composition o f total revenues in2005. Excise taxes on cigarettes and liquor are 8 to 12 percent, on dieselfuel 12 percent and on gasoline ''(nuftus)about 30 percent. Inaddition, the formal private sector (about 20 percent ofthe labor force) pays social securitytaxes of about2 percent of GDP to the Instituto de Previsidn Social which provides health services and pensionsto this group. These taxes do not form part ofthe central administration finances and are hence not included inTable 1.6, but needto betaken into accountwhen assessingParaguay'soverall tax burden. 18 Figure 1.3: C o ~ ~ o s of~ ~ o nGov~rnment ~ Central -___ I OtherNon Tax Revenues Pro& tax 1.6 2.1 1.8 Customs taxes Excisetaxes 1.8 2.2 1.54 Intotal, the central administrationcommands about 18percent of GDPin available resources. Incontrast, preliminary indications for 2005 indicate that the municipalities had total resources of about 2 percent of GDP, or about 10percent of total government revenues (central plus local) - see Figure 1.4 and Appendix Table 2. Municipal revenues appear to have risen from the previously mentioned 1.5 percent o f GDPin2003 due to increasedtransfers ofroyalties (plus 0.3 percent o f GDP) andhigher tax collections inAsuncibn, while tax collection inthe interior declined. evenues of the Central A ~ r n ~ n ~ s t ~andi o n a ~ (as percentof GDP) 19 Chapter 11:The Market Value of RuralLand- Case Study of the Departmentof Caaguazu 2.1 One o f the reasons for the weak performance o f the property tax inParaguay has beenthe extremely low fiscal value (valorfiscal) o f land upon which the tax i s levied. It i s common knowledge that this valorfiscal is significantly below market value, but the gap between the two has thus far not been empirically documented or q~antified.~' Using data from the department o f Caaguazu ineastern Paraguay, this chapter will provide quantitative evidence o f the gap between fiscal and market values inrural areas, and estimate the potential impact on revenue generation ifmarket values were used as the basis o f the tax. Rationale for choosing Caaguazu 2.2 The initial intentionwas to take a large sample indifferent regions ofthe country to prepare a nationally representative estimation o f the market value o f rural land. However, cost constraints made it necessary to significantly limit the scope o f the field work. It was therefore decided to focus on one department and take a sample that would provide reliable and representative estimates for that particular department. Based on these results, some rough estimations could then be made for other parts o f the country. Summary of main characteristics 2.3 The department o f Caaguazu was chosen because it is inmany ways representative o fthe eastern region o f Paraguay, where the overwhelming majority o f the population lives. It i s the fifth largest department interms o f geographic area, andthe third largest interms ofpopulation. The department comprises 20 districts. 2.4 Likeother parts o fParaguay, Caaguazuhas experienced rapidurbanizationo fits population. The share o f the rural population has decreased from 85 percent to 68 percent inthe last 30years. Despitethis trend, 57 percent ofits inhabitantsare still employedin the primary sector, and all but 0.5 percent ofthe department's land surface remains classified as rural (Table 2.1). 30 Molinas Vega (2000) provides estimates ofmarket values in24 districts inthree departments (Caaguani, Concepcionand San Pedro), based on a small, non-random sample. 20 Table 2. 1Caaguazu Rural population and land by district (2002) Rural Share of district Rural land population population (has) RI3 Corrales 7,414 96.7% 32,027 Raul Arsenio Oviedo 26,782 95.3% 136,574 YhU 32,460 94.1% 158,474 La Pastora 4,153 92.2% 21,383 Mariscal Lopez 6,706 90.9% 120,627 3 de Febrero 7,912 88.9% 21,066 San Joaquh 13,222 88.4% 48,176 Santa RosaMbutuy 9,4 17 86.4% 32,138 Simon Bolivar 4,208 84.6% 33,391 Carayao 11,902 84.6% 92,105 Repatriacion 30,094 84.4% 86,73 1 Jose Domingo Ocampos 7,740 83.2% 14,222 Nueva Londres 3,475 81.6% 24,497 JuanManualFrutos 14,751 76.7% 55,110 Vaqueria 7,466 72.9% 115,150 Cecilio Baez 4,6 15 70.4% 14,173 San Jose de 10s Arroyos 10,303 67.3% 49,384 Jose Eulogio Estigarribia 14,823 60.0% 63,607 Caaguazu 52,28 1 51.O% 90,730 Coronel Oviedo* 37,284 43.8% 85,803 TOTAL Caaguazu 307,008 68% 1,295,370 * Capital o f department Source: Direccion General de Estadistica, Encuestas y Censos and Servicio Nacional de Catastro. 2.5 According to the 1991agricultural census, small landholders accountedfor the largestnumber ofplots (88 percent), while large landholdings representedmore thanhalf of all the land (51 percent) (Table 2.2). The distribution was similar inother parts of eastern Paraguay: 85 percent of holdings inthe hands of small farmers, and 72 percent o f all landunderthe control of large landholdings (Table 1.1). Table 2. 2: Pattern of agricultural landholdings in Caaguazu From (ha) to less than (ha) Number of plots Area YOof plots YOof area 0 20 38,159 252,529 88% 28% 20 200 4,953 188,879 11% 21% 200 363 455,636 1Yo 51% TOTAL 43.475 897.044 100% 100% Source: Agricultural Census, 1991. 2.6 Smaller holdings are typically associatedwith the cultivation of cotton, mandioca and corn, while medium-to large holdings are dominated by soy and wheat production, as well as by cattle ranching. It is estimatedthat in2003, approximately 40 percent of the land inthe departmentwas dedicatedto the cultivationof crops, while 42 percent was usedfor raising cattle. The remaining 18percent ofthe Department's surface is occupied by forests andrivers (MAG 2003). 21 2.7 Anecdotal evidence suggests that since the last agricultural census, the landholding pattern has changed inseveral ways. On one hand, the past decade has seen an expansion o f soy cultivation throughout eastern Paraguay, including ineastern Caaguazu, which has ledto a consolidation o f farms and thus to an increase inlarger holdings. On the other hand, between 1990 and 2001 the rural development and land administration agency (INDERT) distributed an estimated 9,000 parcels o f land to small farmers inCaaguazu, counterbalancing to some extent the trend towards consolidation. Overall, it is estimated that there has been a slight increase inthe average size o f landholdings inCaaguazu from 20 to 23 hectares in2002 (MAG 2003). 2.8 The changes inthe crop patterns are even more pronounced: soy productionrose more than five times between 1992 and 2002. According to Molinas Vega (2005), the initial increase inproductionwas due to improvements inproductivity, but inthe late 1990s it was due mainly to an increase incultivated area. By 2002, 7 percent o f all land inCaaguazuwas usedfor soy cultivation. At the sametime, cotton, which usedto beone o f the main crops grown inCaaguazu, has lost inrelative importance. Nevertheless, Caaguazu remains the largest cotton producer inthe country and the third largest producer o f tobacco and wheat. 2.9 Insummary, Caaguazupresents aprofile typical o feastern Paraguay: predominantly rural, with a mixture o f soy-producing large holdings, smallholders, cattle ranching and forests. Other factors that made Caaguazu attractive as a case study site were its proximity to the capital city and ease o f access by road. Description of methodology used to estimate market value 2.10 The most direct way o f determining the market value o f land i s by analyzing sales prices resulting from recent property transactions. These transactions are generally documented by notaries, lawyers or real estate agents. However, there i s a long- established practice inParaguay of under-declaringthe sales price inlegal documents in order reduce the cost o ftitle registration fees, which are set at 2.75 percent o f the declared value o f the property, and to hide the real value o f assets heldby people with questionable sources o f land acquisition. Relying on such documents would therefore not yield realistic estimates o f market values o f rural land. Inorder to determine the "true" sales price and, by extension, market value o f land, a team o f consultants designed and conducted a field survey o f a random sample o fproperties inthe department. These sample values were then used in a geo-statistical model to estimate market values throughout the department. Determination of thesample 2.11 Givencost andtime constraints, the consultants selected a representative sample o f rural properties large enough to allow for reliable estimates at the department level. The team first assembled a comprehensive database comprising soil characteristics, road infrastructure, bodies o f water and other land characteristics, which served as the basis for the sample selection and as inputs to the geo-statistical model usedfor estimation. A 22 more detailed description o f this process i s presented inthe Addendumto Annex 5 (Volume II), "Technical Note on Methodology for Estimating LandValues in Caaguazfi." 2.12 The land characteristics were usedto stratify the department into three physical zones (zonasfisicas, ZF): those with low, mediumand high aptitude for agricultural production. The a priori assumption was that there is a close connection between the level o f agricultural utility and the market value o f land. The ZF map was thencovered with a grid o fpoints, excluding points close to urbanareas, bodies o fwater, flooded lands and other non-relevant areas. Fromthis grid a sample of 455 points was randomly selected, roughly proportional to the total land area o f each ZF (Map 2.1). Map 2. 1:PhysicalZones (ZF) with Sample Points Legend PHYSICAL ZONES DESCRIPTION HIDROGRAPHY MlSC URBAN LOW MEDIUM HIGH Collection of information on samplepoints 2. 3 Given the difficulty incollecting reliable data on property transact,ans from lega documents inthe public registry (Registro Pziblico), field teams with expertise in local land markets (surveyors and land sales professionals) located each o f the 455 sample sites using GPS technology and interviewed the owners o f the parcels to arrive at estimates o f fair market value based on recent sales o f the parcel or nearby parcels with similar characteristics. Inthose cases inwhich the buyer or seller could not be contacted, the team prepared its own estimates based on its knowledge of local real estate conditions. These field visits and estimates o f market value were made inMay/June o f 2006. Values inGuaranies were convertedto US$at G6,000 perUS$. A list ofthe 455 sample properties and their estimated market values is presented inthe Addendum to Annex 5. 23 Estimating market values 2.14 To estimate the market value o f landfor the Department as a whole, a geo- statistical model was used to interpolate the values o f areas lyingbetween the known points o f the sample. The methodology used was the Kriging spatial interpolation method and i s described inmore detail inthe Addendumto Annex 5. Inbrief, Kriging i s a common tool to estimate values for a continuous space based on a sample o f known data points. For each unknownpoint to be estimated, the model assigns weights to nearby sample data based on their relative distance to the point to be estimated. It then "interpolates" the value for the target area usingthe weighted values of the nearby sample data. The main advantage o f the Kriging method i s that it maximizes the use o f spatial information, i.e., the prices o f nearby properties inthe sample. An alternative "hedonic" method was also used, which estimates values based solely on the physical characteristics o f land, but the results were viewed to be less robust thanthe estimates from the fiiging methodology. Again, see the Addendumto Annex 5 for a more detailed discussion o f these two methods and their results. 2.15 Based on the sample data, the Kriging model estimated the market value for each quarter (0.25) hectare inthe department. It then groupedthese estimates into 32 ranges with the average market value o f each range servingas the reference point (Map 2.2). Presented inthe form o f a map with the district limits superimposed, this detailed classification shows the transition o f market values from lowest inthe western part o f the Department to highest inthe eastern part o f the Department. Map 2.2: Rangesof market values in Caaguazi! (in US$ per ha.) 267 268 340 341 408 409 476 477 549 550 627 628 704 ------ 705 - 782 783 860 - 861 - 943 944 - 1030 1031 1113 1114 1191 1192 1269 1270 1346 1347 1424 1425 1502 1503 1580 1581 1653 1654 1721 1722 1794 1795 1872 1873 1949 1950 2027 ------------- 2028 2100 2101 2173 2174 2251 2252 2 2 9 J 2330 2402 ----- 2Y03 - 2475 I 2 4 7 6 I 2 5 5 8 2659-- 2557 24 2.16 To facilitate analysis at a more aggregate level, the 32 clusters were grouped into three "homogenous economic zones" (zonas hornoge`neas econdmicas, ZHE), (Map 2.3 and Table 2.3). Map 2.3: Homogeneous EconomicZones (ZHE; in US$ per ha.) Table 2.3: Market values by ZHE (in US$ per ha.) District Low Medium High Average Carayao 360 0 0 360 Cecilio Baez 369 0 0 369 San Jose de 10s Arroyos 370 0 0 370 LaPastora 383 0 0 383 Nueva Londres 432 0 0 432 SimonBolivar 456 0 0 456 San Joaquin 457 0 0 457 SantaRoseadel Mbutuy 472 0 0 472 RI3 Corrales 5 19 0 0 519 Coronel Oviedo 651 0 0 651 Caaguani 731 1,426 2,064 1,061 3 de Febrero 939 1,145 0 1,121 Repatriacion 870 1,349 1,907 1,157 YhU 766 1,398 1,873 1,174 Jose Doming0 Ocampos 0 1,321 0 1,321 Juan Manuel Frutos 861 1,364 2,012 1,327 Vaqueria 0 1,523 1,934 1,565 Raul Arsenio Oviedo 0 1,436 1,822 1,628 Mariscal Lopez 0 1,635 1,651 1,642 JosC Eulogio Estigarribia 0 1,529 2,155 1,969 Department (weighted average) 550 1,447 1,871 1,100 25 2.17 Districts with the lowest average market value comprise landwith only "low" economic value, while those with higher market values include predominantly land from the mediumand highvalue categories. 2.18 At this point itis useful to look at the correlations betweenthe ZHE, which are based on the estimation model, and the ZF, which are based on factors determining agricultural utility. Overall, bothclassifications assign higher values to the eastern part of the department than to the western part. Butthere are some exceptions: the land inthe municipality o f Jose Eulogio Estigarribia, for instance, has the highest average estimated market value, but only medium agricultural utility according to the ZF classification due to the predominance o f medium- and low-quality soils (alfisol andultisol). However, access to roads i s better than inother parts o f the department, which i s an important factor for those investing inlarge-scale soy cultivation and determinant o f market value.31 2.19 Appendix Table 4 provides the full detail o f high, mediumand low value land in each district, as well as a breakdown into public (non-taxable) and private (taxable) land. For this purpose, public lands (about 28 percent o f Caaguazu) are deemed to comprise those colonized by INDERT (which still holds title on behalf o f the beneficiaries pending payment for their lands), those owned by indigenous groups, andnational parks. While these lands cannot be freely bought and sold, it i s nevertheless useful to assign a market value to these areas. The exact GPS location of INDERTlands within each district was not available, so they were assigned each district's average market value. The GPS location of indigenous lands, on the other hand, was available and the model calculated an estimated value for these lands, which tend to be located inhigh-value areas. Private lands (about 72 percent o f Caaguazu) tend to have higher than average valuations, except for privately-owned forests which tend to be o f a lower value (Table 2.4). Table 2. 4: Summary of Estimated Market Values by Type of Land (US$) Hectares Average value (US$) per ha. Public lands 358,963 886 INDERT 346,614 871 Indigenous 9,977 1,448 NationalParks 2,372 617 Private lands 936,407 1,182 (oiw forests) 68,773 420 Total Caaguazu 1,295,370 1,100 31 While the correlation between agricultural utility and land prices allows us to speculate about potential determinants o f market value, it i s beyond the scope o f this study to conduct a detailed analysis o fthis issue aside from the brief "hedonic" exercise reported inthe previously mentioned Addendum to Annex 5. Nevertheless, Molinas Vega's (2005) regression analysis o f the determinants o f land prices inParaguari, SanPedro and Itapua shed some light on the factors determining landvalues; it shows that soil quality, land titling and distance from roads are significant factors. Inaddition, variables for geographic location (dummy variables for areas close to the border with Brazil and Argentina, areas dominated by smallholders, or areas primarily characterized by colonias), which serve as proxies for the ease with which domestic and foreign markets can be accessed from a certain location, are found to be important. 26 Analysis of Results a) Thegap between market andfiscal values in rural areas 2.20 The results confirmthe perceptionthat fiscal values of landinCaaguazuare far below market values. Butthey also show that there is a large amount of variation among districts. 2.21 First, market values vary considerably acrossthe department(Map 2.4 and Figure 2.1). The district of Jose Eulogio Estigarribia has an average market value of rural land (US$1,969) five times as high as Carayao (US$360), which is located inthe western part o fthe department. The emergence of high-value zones inthe easternpart ofthe departmentis clearly linkedto the presence o f the main silos, cooperatives and large- scale agro-businesses. It i s also relatedto the acquisition of large landholdings by Brazilianinvestors to cultivate soy, following large price increases inthe neighboring department of Alto Paranadue to the same phenomenon. Map 2. 4: Average market values by district (in US$ per ha.) 27 Figure 2. 1: Average market values by district (in US$ per ha.) Carayao Cecilio Baez San Jose de 10s Arroyos La Pastora Nueva Londres S i d n Bolwar San Joaquin Santa Rose del Nbutuy RI3 Corrales CoronelOviedo Caaguazu Department(weighted average) 3 de Febrero Repatriacion Yhu Jose Domngo Ocarrpos Juan Manuel Frutos Vaqueria Raul Arsenio Oviedo Mariscal L6pez Jose Eulogio Estigarribia 0 500 1,000 1,500 2,000 2,500 2.22 Second, while there is some variation infiscal values across districts, this variation i s not explained by actual market conditions. There are only five different fiscal values inuse in Caaguazu, rangingfrom US$17 to US$29, meaningthat many districts have the same fiscal value regardless o f their widely varying average market values. Given that there has beena uniform increase inthese values since 1992,32the relative fiscal value for one district compared with another has not changed at all, and has thus failed to account for changes inlocal land markets. 2.23 As a consequence, the district o fMariscal Lbpez, for instance, is among those districts with the lowest fiscal value (US$17 per hectare), butwith the second highest market value (US$1,642 per hectare). The average market value o f rural land inMariscal Lopez i s thus 99 times the fiscal value. InSan Jose de 10s Arroyos, on the other hand, market values are only 13 times fiscal values (Table 2.5 and Map 2.5). 2.24 Infact, itturns out that there is a slightly negative correlationbetweenmarket and fiscal values, i.e. higher market values are associated with lower fiscal values. For the Department as a whole, the estimated average market value i s 54 times the average fiscal value. 32See Chapter 1 for more details on the evolution o f fiscal values inParaguay. 28 Table 2. 5: Fiscal values (2006) vs. estimatedmarket values in Caaguazu (in US$ per ha.) Average MVas District Fiscal FV as share Value (FV) Market multiple Value (MV) of MV of FV San Jose de 10s Arroyos 29 370 7.7% 13 RI3 Corrales 29 519 5.5% 18 Carayao 19 360 5.2% 19 LaPastora 18 383 4.8% 21 Nueva Londres 20 432 4.7% 21 Cecilio Baez 17 369 4.5% 22 Coronel Oviedo 29 651 4.4% 23 Simon Bolivar 17 456 3.6% 28 San Joaquin 17 457 3.6% 28 Santa Rose del Mbutuy 17 472 3.5% 28 Caaguazu 29 1,061 2.7% 37 Repatriacion 29 1,157 2.5% 41 Jose Doming0Ocampos 29 1,321 2.2% 46 3 de Febrero 17 1,121 1.5% 68 Yhu 17 1,174 1.4% 71 Juan ManuelFrutos 17 1,327 1.3% 80 Vaqueria 17 1,565 1.1% 94 RaulArsenio Oviedo 17 1,628 1.O% 98 Mariscal Lopez 17 1,642 1.O% 99 Jose Eulogio Estigarribia 19 1,969 1.O% 105 Department (weighted average) 20 1.100 1.8% 54 Map 2. 5: Market values expressedas multiples of fiscal values 29 2.25 These results show that fiscal values are even further removed from market values thanpreviously estimated. Basedon a small, non-random sample taken in 11 districts in Caaguazu, Molinas Vega (2000) found that in 1996 fiscal values were close to 6 percent o f market values. The results o f this study suggest that for the department o f Caaguaz6 as a whole, the average fiscal value in2006 is only 1.8 percent o f market values. The difference inthe two estimations may be due to the use o f significantly different methodologies, or they could simply be a function o f increasing disparities due to the spread o f soy cultivation ineastern Paraguay. A comparison o f the estimates for 1996 and 2006 indeedshows that the greatest increase inestimated values occurred inthe districts located inthe eastern part o f the country: JosC Eulogio Estigarribia, RaidArsenio Oviedo, Repatriacibnand Yhu (Table 2.6). Table 2.6: Comparison of estimatedmarket values (Guaranies per ha.) 2006 estimate as 1996" 2006" multiple of 1996 estimate 3 de Febrero 1,242,857 6,725,630 5 Caaguazd 1,081,250 6,365,569 6 Carayao 700,000 2,162,148 3 Cecilio BStez 800,000 2,215,444 3 Coronel Oviedo 1,950,000 3,905,528 2 Jose Eulogio Estigarribia 1,200,000 11,815,810 10 Jose Domingo Ocampos 2,250,000 7,924,552 4 Rad1Arsenio Oviedo 650,000 9,767,004 15 Repatriacibn 928,125 6,943,508 7 YhU 693,571 7,046,289 10 Notes: *1996estimatesare district averages derivedfrom anon-randomsample (Molinas Vega) collectedin 104 communitiesin24 districts, including 11 of the 20 districtsin the department ofCaaguazh (with at least 4 respondentsper district). "2006 estimatesare district averagesderivedfrom a modelbasedon arandom sample (Tavamba'e) Source: Molinas Vega (2000) andTavamba'e (2006). 2.26 The above results provide clear evidence that fiscal values today bear no relation to actual market values. Not only do they under-value land across the board; they also do not reflect agricultural and economic trends that have ledto large discrepancies in land values betweendistricts. b) Potential revenue impact of moving the tax base to market values 2.27 Before estimating the potential revenueimpact o f moving the tax base from fiscal to market values, it i s useful to take a look at the current performance o f the rural property tax. Table 2.7 provides a comparison of actual tax collections from rural properties with an estimate of potential tax revenues usingthe existing fiscal values. Actual tax collections for 2004 were adjusted to a 2006 equivalent by increasing them by the increases infiscal values that occurred in2005 and 2006 (10 percent each year). Estimatedtax collections for 2006 are then compared with potential tax collections based 30 on the number o f taxable hectares ineach district and applying the existing tax rate o f 1 percent to the 2006 fiscal values. Table 2.7: Revenueperformanceof rural property tax (Guaranies) Estimated revenue Potential revenuefrom Estimated actual/ District from rural property rural property tax @ potential revenue tax (2006)" existingfiscalvalues" (YO) Vaqueria 7,218,152 114,457,020 6.3 Nueva Londres 1,444,462 20,010,344 7.2 Mariscal Ldpez 15,058,837 119,605,046 12.6 3 de Febrero 3,325,765 20,977,591 15.9 Raul Arsenio Oviedo 23,593,199 132,176,880 17.8 Yhu 20,136,68 1 110,621,98 1 18.2 Simdn Bolivar 6,167,586 33,219,159 18.6 San JosC de 10s Arroyos 10,890,000 49,473,296 22.0 JosC Domingo Ocampos 5,386,678 24,3533 16 22.1 Carayao 22,s 15,523 100,325,342 22.4 Santa RosaMbutuy 7,578,646 32,003,466 23.7 LaPastora 6,885,809 23,574,547 29.2 Cecilio BBez 1,537,19 1 4,399,7 11 34.9 Juan Manuel Frutos 13,568,16 1 32,816,324 41.3 San Joaquin 8,664,208 17,827,869 48.6 Repatriacidn 18,997,000 32,OS 1,505 59.3 JosC Eulogio Estigarribia 44,539,132 70,288,567 63.4 Caaguazu 67,059,410 52,944,3 77 126.7 Coronel Oviedo 90,3 81,45 1 57,526,434 157.1 RI3 Corrales- 0 0 0 TOTAL 374,947,892 1,048,652,975 35.8 Total in US$ (at G6.000) 62,491 174,776 Notes: A Estimatesof collections for 2006 are basedon actual collections for 2004,adjusted by the changes in fiscal values -*Calculatedrural (10% per annum) and assumingthat 20% of total property tax collections are from ruralproperties. as follows: hectares oftaxable landx 2006 fiscal values x 1%tax rate. No taxable landinRICorrales. Source: Staff calculations basedon data obtained from municipalities. See Appendix Table 6 for the detailed calculations on which these simulations are based. 2.28 For the department as a whole, actual collections o f rural property tax are estimated to be only one-third (35.8 percent) o f potential collections. While two districts (Caaguazfi and Coronel Oviedo) appear to be ~ver-performing,~~all other districts appear to collect significantly less than they should: collection ratios (here defined as actual collections as shares of potential collections) range from 6 percent inVaqueria to 63 percent inJose Eulogio Estigarribia. This indicates that much rural landremains untaxed, and that aggregate revenues from the rural property tax could be increased three-fold 33 The "over-performance'' of Caaguazu and Coronel Oviedo may be due to the practice inthese two districts of charging a minimumamount for smallholders; i.e. an owner of a property of 4 hectares inthe district of Caaguazd is taxed the minimumamount of G 13,500 insteadofthe G 6,848 correspondingto 4 hectares. Other potential reasons include: (i) two districts have large urbanareas where revenue the collection is easier; (ii)they have better revenueadministration than other districts inthe department; and (iii) benefitedf+omtheUSAIDMunicipalFinanceProject. they (from G375 million to G 1.049 million) just by ensuring full collection o f the actual tax on all properties (i.e., attaining full coverage). 2.29 A key assumption for the above calculations is that revenues from rural properties account for only 20 percent o f total property tax revenues. This assumptioni s based on an analysis o f data provided by the tax collection office o f the district o f Caaguazh This ratio i s not known for the other 19 districts as they do not have administrative systems that distinguishbetween urbanand rural collections. The ratio may nevertheless be lower inthe more rural districts, inwhich case current collections wouldbe overestimated in the precedingtable, andthe revenue impact o fimproving tax collectionwould be greater thaninthis illustration. 2.30 One reason why coverage is so low i s that actual collections may not be high enough to induce municipalities to increase their collection efforts. Most o f the tax revenue from rural areas i s not generated through active collection efforts, rather through compliance with legal requirements inspecific situations, such as at the time o f sale o f a property, or when the owner applies for a mortgage. 2.3 1 Table 2.8 extends the above analysis and estimates potential revenue collections if rural properties were assessedat their current market values instead o f the existing fiscal values. Assuming full coverage o f all rural properties, and no change inthe existing tax rate o f one percent, movingthe tax base to market values would increase potential tax collections by 63 times their potential based on current fiscal values and 177 times the estimated actual revenues for 2006, namely, from G375 million actual to G11,066 million based on market values. 32 Table 2.8: Caaguazu potential revenues from rural property tax at market values (Guaranies) - Estimated Potential Potential actual revenue@ revenue @ revenue from Potential Potential market values market values rural revenue@ revenue@ 2006 fiscal market as multiple of as multiple of District property tax estimated potential (2006)" values* values actual revenues @ revenues fiscal values (1) (2) (3) (3) l(1) (3) l(2) Coronel Oviedo 90,381,451 57,526,434 1,3 12,O17,061 15 23 Caaguazu 67,059,410 52,944,377 1,970,3 10,447 29 37 San Joaquin 8,664,208 17,827,869 490,468,048 57 28 San Jose de 10s Arroyos 10,890,000 49,473,296 642,182,704 59 13 Cecilio BAez 1,537,191 4,399,711 97,884,239 64 22 Repatriaci6n 18,997,000 32,051,505 1,243,098,947 65 39 LaPastora 6,885,809 23,574,547 491,265,593 71 21 Carayao 22,5 15,523 100,325,342 1,925,338,374 86 19 Santa RosaMbutuy 7,578,646 32,003,466 910,300,009 120 28 Sim6n Bolivar 6,167,586 33,219,159 913,549,599 148 28 Jose Eulogio Estigarribia 44,539,132 70,288,567 7,349,594,887 165 105 Juan Manuel Frutos 13,568,161 32,816,324 2,625,485,790 194 80 Jose Domingo Ocampos 5,386,678 24,353,5 16 1,127,O 12,194 209 46 Nueva Londres 1,444,462 20,O 10,344 429,053,388 297 21 YhU 20,136,681 110,621,98 1 7,884,788,574 392 71 3 de Febrero 3,325,765 20,977,591 1,416,825,849 426 68 Raul Arsenio Oviedo 23,593,199 132,176,880 12,946,172,284 549 98 Mariscal Ldpez 15,058,837 119,605,046 11,833,382,870 786 99 Vaqueria 7,218,152 114,457,020 10,787,614,501 1,495 94 RI3 Corrales- 0 0 0 TOTAL 374,947,892 1,048,652,975 66.396.345.356 177 63 Total in US$ (at G6000) 62,491 174.776 11.066.057 Notes: A -* Calculatedlandin Estimatesfor 2006 basedon 2004 data. See note to previous table. as follows: hectares of taxable land x 2006 fiscal values x 1%tax rate (see Appendix Table 6). No taxable RICorrales. 2.32 Revenues could be further increased by taxing landthat has beentransferredby INDERTto smallholders, a factor which is not includedinthe above calculations. Currently, lands transferredby INDERTare exempt from the property tax untilfive years after the title is transferredto the individual owner, and then at one-half the standard rate (Le. at 0.5 percent) on holdings o f less than 5 hectares. Ifsubject to the full tax rate at marketvalues, these landscould contribute an additional G 18 billion intax revenues (Table 2.9). Note, however, that one of the reasons why so few smallholdings pay the tax i s that there are long delays intitle transfers, and this problem would have to be tackled if tax revenue from smallholdings were to be increased. 33 Table 2.9: Potentialadditional revenue from INDERT transferred lands Current area (ha.) 346,614 Average estimatedfiscal value (guaranies per ha.) 147,115 Average estimatedmarket value (guaranies per ha.) 5,228,080 Estimatedadditional annualtax revenue(using fiscal values) 509,922,922 Estimated additional annual tax revenue(using market values) 18,121,262,3 16 2.33 On the other hand, a tax exemption of natural forests under certain conditions34 could encourage good environmental practices, while leading only to a modest reduction inactualrevenues.At current fiscal values, the exemption would represent9 percentof total potential revenues; at market values, it would represent only 3 percent of potential revenues (Table 2.10). The actual revenue loss may be minimal, however, since existing forest land may not be payingmuchtax, ifany, at present. Table 2. 10: Potential impact of possible exemption of natural forests from property tax Current area (ha.) 68,773 Average estimatedfiscal value (G per ha.) 134,444 Average estimatedmarket value (G per ha.) 2,519,555 Estimatedpotential revenue iftaxed at fiscal values (assumingfull coverage) 92,460,710 Cost ofpossible exemption as % oftotal potential revenues (using fiscal values) 8.8% Estimatedpotential revenue iftaxed at marketvalues (assumingfull coverage) 1,732,767,236 Cost ofpossible exemption as % oftotal potential revenues (using marketvalues) 2.6% Significance offindings for other departments 2.34 GivenCaaguazu's typical profile, andthe past uniformadjustment of fiscal values for Paraguay as a whole, it is reasonable to assume that other departments face similar discrepanciesbetweenmarket and fiscal values of rural land. The largest differences are most likely to be found inthose departmentsthat have been affected by an increase insoy cultivation: Alto Parana, Itapua andCanindeyu ineasternParaguay, for instance. Other departmentsinwhich soy production does not play as big a role have nevertheless also seen increases inland prices due to the expansion and intensification of cattle ranching. Molinas Vega (2000), for instance, estimates that fiscal values representedonly 8 percent of market values inConcepcibn, and 4 percent in SanPedro. 2.35 Comprehensive data on marketvalues for rural land i s not available for all departments. Nevertheless, some estimates are available. The Banco Nacional de Foment0 (BNF) maintains minimumand maximum prices for landto beusedas guaranteefor loans, andthe Servicio Nacional de Catastro maintains a similar list of market valuations -see Appendix Table 7. Usingthe averages of these estimates, it is possible to approximate potential revenues from the ruralproperty tax for Paraguay as a whole based on market values insteadof fiscal values. 2.36 Table 2.11presents these estimates. For easternParaguay, where the highest increasesinmarket values have taken place, potential property tax collections onrural 34Such as fiscal incentives for maintaining certified natural forests on a sustainablebasis. 34 landare estimatedat US$89 millionper annum. This amount would be 33 times higher than potential revenuesbased on fiscal values (assuming full coverage). BNF and SNC estimatesare not available for western Paraguay(Chaco), but using illustrative estimates of market value, potential revenues are estimatedat US$14 million per annum, about 9 times higher than potential fiscal basedrevenues. For Paraguay as a whole, potential market-basedrevenues would thus be about US$103 million per annum, equivalent to about 1.1percent of GDP for 2006.35 Table 2. 11: Paraguay potential revenues from rural property tax at market values (US$) - Potential Potential collections Average Estimated collections @ market Taxable collections market from rural values as Department Land area from rural (has.) rural land value value property multiple of (has.) ' property tax (US$) tax @ potential per ha. (us$) ' fiscal values per ha.' market collections values @ fiscal values Eastern Region Alto Paranh 1,489,500 1,117,125 37 414,476 1,583 17,687,813 43 Amambay 1,293,300 969,975 25 240,230 365 3,536,367 15 Caaguazu 1,302,398 936,407 19 174,776 863 8,076,509 46 Caazapk 949,600 712,200 21 146,397 700 4,985,400 34 Canindeyu 1,466,700 ,100,025 20 219,749 1,113 12,237,778 56 Central - 246,500 184,875 47 86,253 2,250 4,159,688 48 Concepcion 1,805,100 ,353,825 20 272,454 267 3,610,200 13 Cordillera 494,800 371,100 29 107,493 917 3,401,750 32 Guairfi 384,600 288,450 24 69,354 500 1,442,250 21 Itapua 1,652,500 1,239,375 26 324,647 1,104 13,684,766 42 Misiones 955,600 716,700 22 154,393 421 3,016,113 20 fieembucu 1,214,700 911,025 11 100,234 300 2,733,075 27 Paraguari - 870,500 652,875 29 190,839 807 5,270,605 28 San Pedro 2,000,200 1,500,150 16 241,906 363 5,438,044 22 Sub-total 16,125,998 12,054,107 23 2,743,202 741 89,280,356 33 Chaco Alto ParaguayA 8,234,900 6,587,920 8 498,470 50 3,293,960 7 Boqueron" 9,166,900 7,333,520 8 554,885 50 3,666,760 7 Pdte. Hayes" 7,290,700 5,832,560 8 441,3 16 100 5,832,560 13 Sub-total 24,692,500 19,754,000 8 1,494,672 72 14,185,424 9 TOTAL 40,818,498 31,808,107 13 4,237,874 321 103,465,780 24 (1) Taxable rural land is defined as private land, estimated to be 75% oftotal land area ineach department. This share i s for illustrative purposed only and i s based on actual conditions inCaaguazu where private land i s 72% o f total. (2) Estimates based on data from Banco Nacional de Foment0 and SNC (Ministryo fHacienda) for Eastern Paraguay. See Appendix Table 7. A -EstimatedSNC market values for the Chaco region are purely indicative and for illustrative purposes only. BNFand estimates for Central and Paraguari were arbitrarily cut by halfas they appeared unrealistically high. 2.37 The above estimates are purely illustrative basedon limitedofficial data. Nevertheless, they may be conservative, since the field work conducted in Caaguazu 35Based on preliminary GDP for 2006 o f G51,340 billion, equivalent to US$9,168 million at an average exchange rate o f G5600 per US$. 35 estimates that the average market value o fprivate land (US$1,182) i s 37 percent higher thanthe average BNF/SNC estimates for that department(US$863). Overallpotential revenue may thus be considerable higher than that shown inTable 2.11. 2.38 Using market values for the purpose o f rural property tax assessmentswould have a significant impact on municipal revenue: it could generate more than US$100million in revenues for municipalities, eight times more thanmunicipal revenues from royalties, and almost double total current revenues o f all municipalities excluding Asuncion. Conclusion 2.39 The preceding analysis o frural landprices inCaaguazu shows that the use o f fiscal values for purposes o f the impuesto inmobiliario severely limits the usefulness o f the tax as a revenue instrument. 2.40 First, fiscal values do not reflect the large variations inlandprices across municipalities, which range from US$360 to US$1,969. This i s due to the fact the annual increases infiscal values are (i) limitedto annual inflation and (ii) standardized across the department, failing to reflect economic developments that have ledto higher prices in certainmunicipalities. As a consequence, the gap between fiscal andmarket values has widened more insome municipalities thaninothers. 2.41 Second, current collections are far below what could be expected at the prevailing fiscal values, pointing to weaknesses intax administration. Ifthe existing property tax was actually collected on all taxable rural land, collections would be about three times as high as they currently are. It is clear that any reform inthe property tax system needs to address these weaknesses. 2.42 Third, the continued use o ffiscal values instead o fmarket values means that municipalities inthe Department o f Caaguazu forego G66 billion (US$l 1million) in annual revenues; inother words, assuming full coverage, revenues from the property tax could be 176 times more than what they currently are. At the national level, market- based assessmentsfor rural land could generate potential revenues o f over US$l00 million per annum (about 1.1percent o f GDP), about 24 times higher as those based on existingfiscal values, assuming full collection. 2.43 Finally, the inclusion o f lands transferred by INDERT,which are currently not taxed eventhough they become taxable 5 years after the transfer o f the title, would generate significant additional revenue (G18 billion, or US$3 million, equivalent to about one-quarter o f potential revenues from all private land in Caaguazu). The losses incurred by leaving INDERTland untaxed are thus considerable. Providing a tax exemption for sustainable managed native forests, on the other hand, would not lead to significant losses (about 3 percent o f potential tax revenue). 36 Chapter 111:Evaluating the Relationship of Land Taxation to Non-revenue Policy Goals in Rural Paraguay 3.1 The previous chapters focused on the revenue implications o f improving rural property taxation inParaguay. This section addressestwo key questions about the potential non-revenue impacts o f improving agricultural landtaxation inParaguay: (i) Would more effective landtaxation improve the efficiency o f landuse?; and (ii) Would more effective landtaxation improve the distribution o f landby promoting markettransfers betweenlarger and smaller farm sizes? 3.2 Inshort, the answer to the first question isthat improvedagricultural landtaxation almost certainly would increase landuse efficiency. The answer to the second question i s that improvedland taxation would likely induce a certain amount o f redistributiveland market activity basedon the transfer o f landfrom less efficient to more efficient uses, which inpractice would likely implytransfers from very large operations to mediumsize operations. An improvedrural landtax by itself would likely have little direct redistributive effect toward improving land access for small farms or landless workers. Inassociation with other policies, however, an improved landtax could play an important role instimulating the land market to become more amenableto redistributionto small-size operations. 3.3 The main arguments infavor of landtaxation are basedon economic, socialjustice, and landusejustifications. The principal economic argument is that a pure landtax is non- distortionary, because it has no negative effects on investment or production. Because the land tax is a fixed cost that must be paid whether or not the landi s used for production, it does not penalize production and creates an incentive to develop land to its most profitable use. Inthis regard, landtaxation discourages underutilization o f land and land speculation. Administratively it i s a preferredtype o ftaxation becauseo f its transparency; landi s immobile and cannot be hiddenor disguisedas a bookkeeping transaction. From a social justice perspective, it captures the economic rent that arises from a scare natural resource due to populationpresenceand public infrastructure investment which increase the marketvalue o f land. As such, it i s inherently equitable to tax such "unearned increments" that arise from public actions. From an institutional perspective, the tax can be viewed as a payment to society for the benefits conferred to the landowner for the guarantee o f private property. 3.4 Experience from around the world reflected inthe land taxation literature supports the view that when the tax is significant andwell-administered, the effect o f landtaxation on intensifying land use is strong. Nevertheless, it i s also apparent that achievement o f these effects inthe developing world has beenelusive due mainly to low tax rates, low assessed values and limitedadministrative capacity. The ideathat the intensification o f landuse as a resultofmore effective taxation will also leadto some redistribution from less efficient to more efficient farms through marketsi s supported by international experience, but not necessarily ina way which will benefitthe smallest farmers. Nevertheless, these arguments suggest that by intensifyinglanduse and activating landmarkets, improved landtaxation may be an important element o f a package o f landpolicies geared towards achieving greater rural employment and eventually less concentrated land distribution. 37 3.5 This chapter reviewsthese arguments inthe context o frural Paraguay basedon examination of data on land distribution, landmarketsand landuse inParaguay. What the literature has to say about non-revenue impacts of land taxation. 3.6 The economic intuition about the landutilization effect o f land taxation i s that any factor which raises the cost o f holding underutilized land creates an incentive to increase utilization. Iflandi s not usedat its optimal intensity, thenraising the cost o f holding land through a tax should induce greater effort for landutilization (see Figure 1). As will be examined below, there i s good reasonto believe that a significant quantity o f agricultural land inParaguay i s not used at its optimal intensity for a variety o f historical and institutional reasons, andthat more effective landtaxation would thus lead to more intensive landuse. Figure 3. 1: Increasein land use intensityas a result of land tax cost of Holding Land C' with tax C without tax Quantity of Land Q without tax Q' with tax Usedat Optimal Intensity 3.7 The figure illustrates a situation inwhich the supply of landused at optimal intensity i s elastic over some range. This curve could apply to either an individual landholder or an economy. As the tax i s imposed (the move from C to C') the landholder increasesthe quantityo flandusedat optimal intensity(the move from Q to Q'). 3.8 The above observation is born out empirically. Wunderlich (1993), ina survey of agricultural landtaxation inthe US concludes from an exhaustive review o ftime-series data that there i s "a positive relationship betweenhigher property tax rates and more intensiveuse of farmland, which inturn i s associatedwith more equal distribution o f farmland." Yamamura (1986) makes the same case for Japan, linking the imposition o f a land tax to increased agriculturalproductivity. Strasma (2000) points out how the structure o f Chile's agricultural landtaxation system successfully encourages full utilization o f the landby basing assessmentson the potentialprofitability o f each landparcel, which are updated regularly basedon a table of actual market transactions. 38 3.9 The impact o f agricultural landtaxation as a mechanism for inducing redistributive markettransfers, on the other hand, is not as clear. Considering Brazil, Assuncao and Moreira (2005) note that the landtax (Rural Property Tax) inBrazil i s intendedto support public policies for landredistribution, but has had little success. They note that there i s a high level of evasion and default that hinders its efficiency as an instrumento f landholdingpolicy, but still conclude that "appropriate landtaxes might correct landprices ineconomies where they are above the discounted presentvalue of agricultural inflows, inducing land redistributionfrom large landowners to more productive small peasants." Similartax policies, it i s worth noting have been applied inthe Caribbean inplaces such as St. Lucia and Jamaica, also with mixedresults. Strasmaet al. (1987) concludes that the use o f agricultural landtaxes for stimulating redistributionhas not yet succeededbecause land taxes are imposed at too low a rate to affect the decisions o f property owners. Shearer, et al. (1991) are guardedly optimistic about landtaxation as a policy tool to encourage redistributioninthe LatinAmerican context, but call for more research. 3.10 Other economists have expressedskepticism about both the landintensificationand redistributive effects o f agricultural landtaxation, but the skepticism turns out to hingeon the specific circumstances under which the tax i s applied. Skinner (1991a and 1991b), for example, believes that it i s not clear at a theoretical level why a landtax should encourage more productive use o f land, unless it i s tied to a reductioninexport taxation (which would increasedomestic output prices) because, "by definition an efficient tax should not affect landuse decisions." But he goes on to say, however, that, "it i s possible that a sufficiently large landtax could spur landowners to work harder (an income effect) or to break away from reliance on traditional methods o f productionand seek new and more efficient methods." So ineffect, Skinner answers his own critique by again pointing out the incentive that an agricultural landtax createsto intensify effort, especially inplaces where there i s reliance on traditional methods, or even more pointedly where landi s beingheldfor non- productive reasons which have to do with imperfections inother markets (e.g., as a store of value due to low confidence inthe financial system). 3.11 Skinner also expresseddoubts that landtaxesreduce speculation inlandbecausethe tax only results ina one-time landprice reduction. This critique i s valid inthe circumstance inwhich landisthe only asset the investor holds. Butwhenan investor has the opportunity to invest ina variety o f assets andthe rate o f returno f one o f them (e.g., land) i s lowered, the investor will shift investmentaway from that asset. Especially ina progressive landtaxation scheme, such shiftingo f incentives could induce markettransfers o f land. Skinner also objects to landtaxation as an instrumentfor landreform. He says that: "efforts to encourage landreform thoughthis channel inColombia and other countries have generally been unsuccessful for two reasons: First commonly administered land tax rates have beenneither large enough nor progressive enough to affect land use. Inone study o f Colombia, L.Harland Davis concluded that: this fact means that there is little opportunity for the non fiscal effects to operate ... `Because o f low rates the tax burdenis a relatively small percentage o f income and particularly...among the larger farmers, where the tax burdeni s lightest."' 3.12 Low rates are the problem noted here, not the economic incentives created by the land tax. But infact rates, while typically somewhat lower inLatin America than inOECD 39 countries, are much less critical than below-market-value assessments inthe failure o f Latin American rural landtaxes to have significant impacts on landuse decisions. The issue for Latin American land use intensificationi s thus what level o f assessment and what tax rates could together change behavior andthe willingness to intensify landuse through technical change or by renting out or selling the land. Most o fthe observed rates inLatin America's agricultural land are somewhat lower than OECD countries, but combined with very low assessmentsthey generate amounts o ftax which are scarcely worth collecting and have little presumedeconomic relevance to landholders. 3.13 Two important questions which needto be answered to assess the non-revenue impact o f improved landtaxation inParaguay are therefore: 1) Does there exist a significant quantity of landwhich i s economically underutilized, and 2) I s the existingagricultural landtax sufficient to induce changes inthe behavior o f landholders and leadto intensificationo fuse? Chapter I1presented a range o f evidence which casts major doubts on the efficacy o f the existing tax to create land use incentives because o f severe, chronic under-assessmentof land values, so this section focuses onthe first question. An increase inthe landtax i s likely to induce a significant intensificationo f land use only ifthere i s a significant quantity o f underutilized land inthe first place and the factors for intensification can be cheaply mobilized into agriculturalproduction. As we shall see below there are good reasonsto believethat there i s significant underutilizationof land (i.e., departures from socially optimal factor productivity) inParaguay. It i s also clear that excess labor supply i s readily available. Access to additional capital, however, is probably a constraint for many producers, particularly small farmers. Land Utilization and Markets in Paraguay 3.14 Paraguay's land distribution and structure o fproduction have characteristics which suggestthat a significant amount o f landi s underutilized. These characteristics are: a highly unequal landdistribution based on a historically determined, non-market initial allocation, strong evidence o f an inverse relationship betweenfarm size and productivity, significant areas inextensive cattle ranching, and highrural underemployment. Also, there are a number ofnon-productive reasonsfor holding landinParaguay: landis heldas ahedge against inflation, as a hedge against banking or financial crises, and as a symbol of social prestige. 3.15 Land concentration does not by itselfmean landi s underutilized. But ifthe structure o fproduction also shows a strong inverse size productivity relationship (Le., that small farms are more productivethan large ones), then land concentration i s an indirect indicator o f socially inefficient landutilization. Data show that land concentration is severe inParaguay, although the trendhas ceasedto worsen over the last fifteen years and has improved slightly since 1991, primarily due to transfers from very large to mediumsize operations. According to data processedby FAO, the Gini coefficient for agricultural land increased from 0.89 in 1981to 0.93 in 1991 (Molinas 1997). Other calculations basedon MAGdata for 1991 and 2002 indicate that the Gini coefficient for the easternpart o fthe country declined from 0.87 in 1991to 0.85 in2002, which is still avery concentrated landtenure pattern The FAO's table on landconcentration (below) describesthis distribution. 40 Table 3. 1: Quantity and Area of Agricultural Landholdingsin Eastern Paraguay by Farm Size Source: FAO, 2005 based on MAG, EstadisticasAgropecuarias, 2004.36 3.16 Table 3.1 shows that farms with less than 20 hectares represent 84 percent o f landholdings but only account for 14 percent o fthe agricultural area during 2002. At the other extreme, the farms o f greater than 10,000 hectares, which represent only 0.03 percent o f holdings account for 15 percent o f agricultural landarea inthe same year. This comparison underlinesthe high concentration o f land ownership inParaguay, inwhich a few large farms account for more areausedinagriculture than 84 percent o f farms. This concentrated ownership pattern raises questions about overall intensity o f landuse, as the abundant labor o f Paraguay's rural economy i s concentrated ina small amount o f land onthe numerous small farms. 3.17 The concentration nevertheless appearsto be declining to some extent inthe largest size classes. From 1991to 2002, there was an overall increase o f 740,000 has. inareaunder cultivation, all o fwhich occurred infarms o f less than 5,000 has. Inaddition, farms over 5,000 hectaresreduced their area under cultivation by about 700,000. Some redistributioni s thus occurring inresponseto marketforces, although the overall patternremains concentrated. 3.18 Table 3.2 shows that pasture and cattle ranching dominate land use inthe largest size categories inthe Easternpart o fthe country where the agriculturally active populationi s concentrated. Only 19.4 percent o fthe land i s usedfor annual or permanent crops according to the 2002 MAGdata, while 55 percent i s inpasture and ranching. This distribution o f use i s evenmore pronounced when analyzed by size category. While smaller farms under 100 hectares use 40 percent o f their landfor crops, farms above 100hectares utilize only 12.3 percent o ftheir area for crops and 65 percent for pasture. The aggregate data thus suggest a much less intensive pattern o f land use inthe larger farms thaninthe smaller ones. These aggregate landuse statistics demonstrate the prevalence o f conditions inwhich changes in landuse or landmarkettransfers from larger to smaller farm classes could intensify overall production. 36 Datafiom 1991are censusdata. Datafrom 2002 are koma censuso flargeholdingsanda representative sampleof smallandmediumholdingscarriedout by MAG. 41 Table 3.2: Land Use in EasternParaguay, by Farm Size (2003) 3 19 I The evidence also confirms that the smaller farm sizes are more intensive users of agricultural landinParaguay than larger farms. This i s not surprisinggiventhe large amount o f evidence worldwide that small farms are typically more productive than larger ones. This relationship, often referred to as the inverse relationship between farm size and productivity can be the result o f diverse factors: (i) greater intensity o f landuse at small sizes; (ii) higher landvalues o f smaller farms which creates incentives for greater intensity o f use; (iii) greater utilizationo f family labor, which i s more efficient than hiredlabor due to lower supervision costs; (iv) distinct diversification strategies on smaller farms; and (v) populationpressure on areas o f best soils. 3.20 Molinas-Vega (2005) asks whether the relationship holds for Paraguay. Ifit infact does, thenthere are potentially efficiency-enhancing landtransfers across size-classes which could benefit the entire economy, and therefore also, implicitly reduce underutilization of land inthe larger farm-size categories. Drawing on Masterson and Rao (1999),and Molinas- Vega and Masterson (2000), Molinas-Vegatests the relationship for Paraguayan agri~ulture.~'The results are robust across a variety o f estimation techniques, confirming the relationship after controlling for land quality, number o fparcels, tenure security, producer characteristics, family labor percentage, access to credit and technical assistance, utilization o f conservation techniques and membershipincooperatives. 38 3.21 The inverse relationbetweenfarm size and landproductivity impliesthat the reallocation o f a hectare o f land from aproductive unit o f 1000hectares to a unit under 10 hectares would increase agriculturalproductionby approximately 48,500Gha. according to the estimations cited. Inthis situation the underlyingproduction economics ofagriculture in Paraguaycould support more intensive land utilizationassuming that land could effectively betransferred to producers with sufficient technology and capital to intensify landuse. 37 "El Papel de laAgricultura en Paraguay: Desafios actuales y perspectivas futuras" 2005. @recessed). 38 The econometric results about the inverse relationship inParaguay, reported in Molinas and Masterson (20002) is shown in five alternative specifications which vary slightly inthe assumptions about the linearity of the effects measured. Ineach alternative specification, the relationshipbetween size o ffarm andthe index of land productivity is negative and statistically significant to the at least the 95% level o f confidence. 42 3.22 Such market induced landtransfers have been limited inParaguay, however, given the capital constraints of small andmediumfarms. Carter and Salgado (2000) characterize the operation ofthe landpurchasemarket inParaguay inthe early 1990s,taking into account whether or not households are rationed intheir access to capital. Their econometric results offer an interesting portrayal o f how the landmarket actually works inthe absence o f a significant land tax. Inwhat they call the Minifundia and Colonizationregions o f Eastern Paraguay, there appear to be large incentives for sale o f landfrom larger to smaller farms basedon the observed "shadow" values o f land o f the smaller farms intheir income functions. However, the purchase market does not operate as a mechanism o f landaccess for labor abundant, capital-constrained households, specifically because the lack o f access to financing makes purchases impossible, even when the household's reservation price to acquire landi s sufficiently high. They further findthat only when agents are capital- unconstrained does their relative technical efficiency actually appear able to express itself as effective demand for more land. That is, the "poor but efficient" do not do well inthe land purchasemarket due to the lack o f long-term and operating capital to finance purchases. In the Frontier soy-producing areas, however, the class competitiveness regime signals incentives for structural change inprecisely the opposite direction as capital-abundant larger farms can easily buy out smaller operations. 3.23 The question is thus would a stronger landtax actually helpto induce these types of transfers from larger farm sizes to smaller size farms, and thus helpto improve the pattern o f the land distribution? Theprimafacie case basedonthe landmarkettrendsnotedabove is that it would accomplish this for mediumand some small producers at realistic levels o f taxation, holding all other variables constant, but it would have little impact for the landless or very small landholders. Nevertheless, becausethe landtax reduces the price o f land and raises the annual costs o f holding it as a speculative asset, it i s a policy that would complement the existing agrarian reformprogramby lowering the cost o f purchasing land. 3.24 The level o ftaxation at which point this incentive to sell landwould become significant depends on the alternative investmentsto landholding which are available to landholders. Ifthe taxation o f landreduces returns on it by enough that alternative investmentshave higher returns, thenwe could expect greater supply o f landto the market. The question i s whether the existing landtax has enough "bite" to make this process work? Effect of Land Tax on the Market Value of Land 3.25 Table 3.3 presents a numerical example o f how the landtax reduces the market value o f land under different assumptions about discount rates and income flows. The first set o f calculations show how the marketvalue o f land can be seen to be equivalent to the present value o f a flow o f net annual income to the landowner over a 20 year period, discounted at a given discount rate. Using a discount rate o f 9 percent (the actual rate for Paraguayan Treasury bonds inUS$), land which yields a net "economic rent" o f 100(Le., after all productioncosts) would be valued at 913. Scenarios with discount rates o f 7 and 11percent are also presented to illustratethat the higher the discount rate, the lower the market value o f land, and visa-versa. These illustrations do not include any speculative value that the market may attach to land which, ifpresent, would increase the value above its pure "economic rent" value. 43 Table 3.3: Effect of Land Tax on the Market Value of Land Market value =presentvalue of future net income flows Discountrate 7Yo 9Yo 11% time horizon (years) 20 20 20 Expectednet annual income flow 100 100 100 Market value of land without tax 1,059 913 796 landtax = 1% market value 10.59 9.13 7.96 Annual flow after tax 89.41 90.87 92.04 market value of land after tax 947 830 733 reductioninmarket value (%) 10.6% 9.1% 8.0% Annual net flow from beef(US$) / ha. 70 70 70 present value of landwithout tax 742 639 557 landtax = 1YOmarket value 7.42 6.39 5.57 Annual flow after tax 62.58 63.61 64.43 Marketvalue of landaftertax 663 581 513 reductioninmarket value (YO) 10.6% 9.1% 8.0% Annual net flow from soybean (US$) I ha. 239 239 239 present value of landwithout tax 2,532 2,182 1,903 landtax = 1% market value 25.32 21.82 19.03 Annual flow after tax 213.68 217.18 219.97 Market value of landafter tax 2,264 1,983 1,752 reductioninmarket value (YO) 10.6% 9.1% 8.0% 3.26 The second set o f calculations show how a landtax of 1percent per annumonthe market value o f landreduces the annual net income flows and inturnthe after-tax market value o f land. At a discount rate o f 9 percent, a 1percent tax on the market value o f land would lower the net annual income to 90.87 and, as a result, lower the after-tax marketvalue of landby 9.1 percent. While the tax lowers the net income for each year, its impact on the market value o f land i s a one-time effect. 3.27 The thirdand fourth sets of calculations introduce examples ofhow the marketmight value landfor beef and soy production. The beef example i s based on a low-intensity, natural pasture scenario for the Eastern Region at the current market price o f about US$0.90/kg.39 Net returns usingimprovedpasture and fencing for herdrotation might be twice as high. The soy scenario i s based on an avera e yield o f 2,500kglha at the average 2005-06 price for soybean for delivery inParaguay. 8 3.28 The table shows that a rancher who, with a given state o ftechnology and capital could expect to obtain a net annual yield o fUS$70 per annum inbeef production per ha. on a givenpiece of land, would value such land at US$639per ha. before tax (under the 9 percent discount rate scenario). A soy farmer, however, mightview the same piece of land as 39Assumes one headper hectare gaining about 150kg. per annum, net of maintenance costs, transportto Asuncionmarket and intereston the capital costs o fbuying the cow for fattening. 40Average price (Chicago) for 2005-06 was US$270 per MT, less about US$60 for transport from Paraguayto world market. 44 capable o f producingUS$239 per annum innet returns, inwhich case he would value the landat US$2,182. Ifthe landwere valued for tax assessmentpurposes at its full market value, namelyUS$2,182, with a resulting tax o fUS$21.82, the tax burdenon soy production would be 9.1 percent of net income (US$21.80 / US$239). Ifthe landwere left incattle production, however, the tax burdenwould be muchhigher, about 31percent (or US$21.82 / US$70 of beef income). The cattle rancher would thus have a strong incentiveto increase the intensity o f his beefproduction, or to shift production into more profitable crops. 3.29 These are, o f course, illustrative examples, but the principle i s that by taxing landat its full market value, an incentive i s createdto increase landutilization and productivity on land which i s beingusedat less than optimal intensity. While a landowner always has an incentive to exploit his landefficiently, these incentives are weaker whenthe landtax i s zero or insignificant, as i s the case at present inParaguay. Conclusions 3.30 Inthis section, we reviewedthe arguments for landtaxation which suggestthat a significant non-revenue benefit o f higher landtaxation i s the intensification o f agricultural land use and that a higher tax could have some impact on reducing land concentration in Paraguay. So far LatinAmerican experiences have not demonstrated significant landuse changes or landmarket effects from agricultural landtaxation, butthis appearsto be due to the region's weak property tax administration, below-market-value assessments, low tax rates, and low collection rates. 3.3 1 The specific consideration of landuse inParaguay suggests that there is awidespread underutilizationo f land. This conclusion i s reached indirectly, through observation of high land concentration inan economy inwhich smaller farm sizes have been shown to be more productive, from data on the extent and returns to cattle ranching versus high-yieldsoy production, and from the abundance o f agricultural labor. Inthis context o f widespread underutilizationo f land, an improvedagricultural landtax would likely intensify landuse and reduce speculative landholding. 3.32 Finally, the section asks whether a landtax would induce market transfers ina redistributive fashion from larger to smaller farms. Our examples suggest that especially in extensive cattle-ranching systems (although probably not insoy systems), a realistically designed agricultural landtax could induce landholders to increase the intensity o f land use for cattle ranching inorder to increase returns per hectare, or to reduce their investmentin land holdings. This could induce an increased supply o f landto the market, probably resulting infurther redistribution from very large holdings to mediumsized farms, a trend already apparent inthe Paraguayan landmarket since the beginning o f the soy boom. Redistributionto small capital constrained farmers would not readily occur, butbecause a higher landtax would lower the market price o f land, it would facilitate programs that finance the purchase of land for small farmers and could thus be part o f a more comprehensive land redistribution policy if accompanied by technology transfers and marketing support to the small farm sector. 45 Chapter IV: International and RegionalExperience with Property Taxation 4.1 Taxes on property (land, buildings, and other improvements) have beenin existence for a long time all over the world. National tax systems have been inplace for some time without major changes innearly all OECD countries: inEurope, for twenty years or more; inJapan, North America, Australia, andNew Zealand for even longer. The property tax has also been introduced ina large majority o f LatinAmerican countries, but i s structured and administered ina great variety o f ways in differentjurisdictions. 4.2 Property taxes inOECD countries represent about 1.9 percent o f GDP, on average, and more than 3 percent o f GDP inAustralia, Canada, the UnitedKingdom and the UnitedStates. This relationship to GDP hasremainedrelatively constant over the past 30 years, while their importance interms o ftotal tax revenues declined somewhat since the 1970sto about 5.6 percent, on average, in2003 (although property taxes still account for more thanten percent o ftotal tax revenues inCanada, Japan and the United States). 4.3 Taxes on property are a less significant source o f revenueinmost Latin American countries, eventhough most countries have long established property tax systems. Inthe 1990s, property taxes accounted for less than 0.5 percent o f GDP, on average, inLatin American countries and about 2.5 percent o f total government revenues. However, the period 2000-2003 shows an upwardtrend, with property taxes risingto about 4.5 percent o ftotal tax revenues (inArgentina and Uruguay they exceedthe OECD average and account for 11.2 percent and 9.2 percent o ftotal revenues, respectively), but still on average less than 1percent of GDP. Table 4. 1: Taxes on property, 1970-2003, in percent of GDP, regional averages 1970 1975 1980 1985 1990 1995 2000 2001 2002 2003 OECD 1.9 1.8 1.6 1.7 1.9 1.8 1.9 1.9 1.9 1.9 Latin _ _ -- _ _ _- 0.4 0.2 0.4 0.5 0.6 0.7 America 1970 1975 1980 1985 1990 1995 2000 2001 2002 2003 OECD 7.1 6.3 5.3 5.2 5.7 5.5 5.5 5.5 5.5 5.6 Latin _ _ _ _ -- _ _ 2.3 2 2.7 3.5 4.3 4.5 America 41 ~ 1levels of government. 1 46 Table 4.3: Relative Importance of Property Taxes, 2003 Source: Revenue Statistics 1965-2004, (OECD) 2005; Government Finance Statistics (IMF); International Financial Statistics (IMF); and World Economic Outlook (IMF) 2005. Bird and Slack 2004, "International Handbook of Land and Property Taxation". Staff est. for Paraguay. 4.4 However, the importance o f the property tax i s not inrelationto the national tax base, but rather to the tax base o f local governments. The property tax i s usually, but not always, a local tax (the rural property tax i s administered at the provincial level in Argentina and at the central level inChile). It i s traditionally considered an important revenue source to local governments, giventhat property i s immovable and i s located within thejurisdiction of a specific local government. The related tax is thus difficult to avoid. It is a significant source o f local revenues especially inrural areas where land i s usually the only tax base. 4.5 On average, the property tax accounts for about 46 percent o ftotal local tax revenues inOECD countries and for about 42 percent inLatin American countries. It i s usually a benefit-based tax and i s set to capture, as closely as possible, the cost of services provided. Infact, makingthe connection betweendelivery o f local public services and revenue collected from the property tax more evident to taxpayers has showed to contribute to a better collection rate (e.g., inColombia). A direct link i s established between property tax and benefits to the community when revenues raised locally are spent locally for the benefit o f the local tax payers. Property taxes assignedto and managedby municipalities have provento be on average more efficient. 4.6 Variations inthe performance o fproperty taxes depend on political will, which differs enormously among countries andmunicipalities. International experience shows that property taxes are overall politically unpopular and that, often, reforms have proven to be difficult or impossible to implement(as inthe case o f Germany), given the unwillingness of politicians to deal with the complexities o f the land taxation system. In other cases, efforts to reform property and landtaxation systems - when well designed and political oppositionhandled -have been successful increating a relatively effective mechanism to raise (local) revenues (e.g., inColombia). 42Dueto limited data, average for propertytax as percentageof local revenues is basedonly on countries shown intable plus Mexico. 47 4.7 Property taxes vary greatly not only among countries but often also withinthe same country, depending on: (i) the tax base i s determinedand the tax rates are how calculated, and (ii) degree o f local government autonomy inestablishing the baseand the settingthe rates. Similarly, the responsibility for assessingand collecting the tax may fall on different levels o f government with different levels o f capacity, dependingon the national and/or local conditions and circumstances. The main features o fthe property tax systems inselected OECD and LatinAmerican countries are summarized inthe following matrix (Table 4.4.) and are described in greater detail inAnnex 6 o f Volume 11. 4.8 Despitethe complexity and the diversity o f landtaxation systems worldwide, some approaches to property taxation are emergingas good practices inthe international experience. We analyze these inthe following sections. Tax base 4.9 The tax basemay be the landonly (e.g., inAustralia insome cases), the buildings only, the land and buildingsand other improvements, or various combinations o f these factors. The tax base for agricultural land usually includes only land, although insome cases it also includes improvements (e.g., inArgentina; inGermany, where the tax base includes all that serves to maintain the agricultural or forestry business -land, buildings, machinery and livestock; and inChile, where it includes the value o f land and improvements above a fixed amount). 4.10 Inprinciple, atax onthe landonly (site value taxation) would bepreferable inthat it gives the owner the incentiveto develop the landto its most efficient andproductive use. However, most countries tax both landand buildings/improvements, either applying a single tax or two separatetaxes. Taxing land only (excluding improvements) leads to difficulties inthe valuation o f urbanproperty, where the values o f land and improvements are not easily separable inan objective, accurate and efficient manner.Valuing land separately may be less of a probleminrural areas, giventhat inthese areas land and improvements are often assessed separately inany case, and that land often constitutes a significant tax base initself. 48 Table 4. 4: Comparison of Property Taxes among Sample OECD and Latin American Countries Country Tax Base Tax Assessment Tax Rates Rural/ Agric. Responsibility for Land Assessment Collection Canada Land and Close to market Ratesrange from Assessed at values Province Municipality improvements. value: average ofthe 1.4% to 4% for incurrentuse (vs. currentvalue of the different classes of potential); rates tax year and the value property; local limited to 25% of of previoustax year. discretion. residential tax rate; Frequency of other tax-related reassessmentvaries incentives. among provinces. State land tax levied Marketvalue at the Rates range from Lower tax rates; State (not Municipality on land; municipal date of valuation, 0.7% to 3% for land used in Federal) rates levied on land rentalvalue or different land uses; primary production only or landand combination of those; local discretion exempt inalmost improvements. valuations although limits on all states. determined at the annual increase. state level and periodically reassessed(from 1to 7 years depending on the state). Land and Marketvalue; annual Rates range from Lower assessed State (not County; improvements. reassessment. 0.5% tO 3%. values especiallyat Federal); Municipality Agricultural land urban fringes. County taxed on average at 0.7-0.85%. Land and Marketvalue Base ratesrange Tax rates higher Municipality Municipality improvements; farm (althoughbased on from 0.26 (one- but appliedto property includes estimatedeconomic family houses)to estimated also machineryand values from 1964); 0.6 YO(agriculture economic values of livestock. price adjustment and forest lands); 1964; low rateable mechanismdoes not leveragefactors value and exempt exist; area-based establishedat the from businesstax. assessmentusedfor local level. buildings. Land, buildings, and Market value with Ratesdetermined Assessed at 55% Municipality, Municipality fixed businessassets. uniform assessment at the national of market value, based on formula established level: standard rate except for uniform at national level; is 1.4%, up to a agriculture land in national reassessmentsevery maximum of 2.1% urbanization areas formula. 3 years. at the discretionof which is assessed the municipality. at full market value; tax concessionsto dispose of farmland. Land andbuildings Cadastral value Ordinary rate: Lower tax rate Central Municipality readjustedevery 8 0.40% inurban Government years through market areas and 0.30% in (not federal). analyses, but never rural areas. exceeds 50% of Municipalities can market value). increasethese rates: the range is roughly 0.5% to 1Yo. 49 Table 4.4: Comparison of Property Taxes among Sample OECD and Latin American Countries (cont.) Country Tax Base Tax Assessment Tax Rates RuraV Responsibilityfor Agric. Land Assessment I Collection LatinAmei Argentina Landand Fiscal value which is Vary among provinces Value based Province and Province and buildings. (In a generally 40%-60% below andmunicipalities: in on land municipality municipality few cases, urban market value, is adjusted urban areas rangei s productivity, land is subject to mnually with tax from 1%-1.5% for area, location. bothprovincial :oefficients to meet provincial tax and Rural tax i s and municipal revenue requirements. 0.7%-1% for municipal payable in property Periodicassessments are tax; higher rates for three to four taxation). :arried out to keep up with vacant lots. installments. market value. Inruralareas: uniform tax rate up to a maximum 1.2%. Colombia Land and Cadastralvalues are 70%- Range established by Small rural Central Municipality buildings 85% ofmarket values; they Congress, 0.1%-1.6%, property is Government are adjusted on an annual within which taxed at the (not federal) basis using index set by municipalities can minimum rate or nationalgovernment, while choose; rates also vary established by municipality the cadastre is updated by use (industrial, municipal (self- every 7 years; or self- commercial, council. assessment). assessmentin certain agricultural); for land jurisdictions (e.g. Bogota). that can be urbanized rate is up to 3.3%. Chile Land, buildings Cadastral value Rates centrally set: Value as low Central Central and approximately 70% of agricultural land 1%; as 25% of Government Government. improvements; market value; non-agricultural land: market value (Revenues for farm lands, reassessmentshould occur 1.2%; (for residencesa and based on returnedto land and between3 and 5 years; 3-bracket system is current use; municipalities improvements cadastral value adjusted appliedthat goes from exemptions under revenue (e.g. irrigation). for inflation every 6 exemptionto a 1.2% for low value sharing months. rate). propertiesand formula). forest lands with approved management ulans Uruguay Land and Cadastralvalue, set as Rates vary from Exemption Department Department buildings, public closely as possibleto department to for forest improvements. market value, i s set department: e.g., in land; ad hoc annually by National Montevideo rates in reductionsin Directorateof Cadastre; urbanareas range from difficult years for rural land, cadastral 0.84% to 1.63%; rate of ("Urgency value is calculatedtaking 1.25% for rural areas. Laws"). into account productivity index set by CONEAT. Paraguay Urban areas: Fiscal values are less than 1% of fiscal value per Rate Central Municipality landand 10%of marketvalue. year. reduction of Government improvements; Fiscal values set by the 50% for rural rural areas: land NationalCadastre Service. propertiesless only. Law requires values to than 5 has. increaseto marketprices, Additional tax but increases limited to ranging from increase in cost of living 0.5% to 1% index with maximum of on properties 15% per year. larger than 10,000 has. 50 Tax assessment 4.1 1 The property tax i s most commonly a market value-based tax, especially inall OECD countries but also insome Latin America countries (e.g., Argentina), although area-based assessment or self-assessment methods are also used. Under the marketvalue assessmentapproach -where the value o f a landparcel is that determined ina market transaction -the need for an adequate cadastre, as complete as possible interms o f coverage and containing basic informationneededfor assessing different types o f properties, i s an important element, as i s the availability o f valuation knowledge and property management skills for periodic reassessmentsto maintainthe tax base accurate andup to date. Additionally, the existence of anappeal process independentfrom the valuation function i s also a key component of a market-basedproperty taxation system, as it allows for a formal process to address taxpayers' concerns regarding the valuation process. 4.12 Most o f LatinAmerican countries rely on cadastral values, as determinedby national cadastral agencies taking as a reference the market value. These values are generally below market values, reaching about 70-80 percent o f market values inurban areas and as low as 2 percent o f market values inrural areas (e.g., inParaguay). Insome cases (e.g. inChile) the area-basedassessmentapproach i s used, whereby the tax is calculated per square meter o f land area or building, so that the tax i s directly a function of the size o f the land or buildings. Taxes basedon area-assessmenthave shownto be regressive (the same tax would be charged to two equal-sized properties invery different land quality locations). Area-based assessments are, however, easy to administer where real estatemarkets are not well developed (e.g., inEasternEuropean countries). Area- based assessment adjusted for location, soil fertility, and other factors, i s often usedto assessthe value o f agriculture land. Inthe case o f Chile, the value o f agricultural landi s calculated taking into consideration the actual landuse (e.g., whether there i s irrigation or not), and its location. Insome cases, the rental value assessment approach i s used, whereby property i s assessed according to estimated rental value (e.g., in some instances inAustralia). 4.13 Self-assessmenti s an appealing procedure incountries with little administrative capacity.43 Positive experiences have beenreported with self-assessmentinseveral countries. InHungary, for example, using the principle o f self-identification, taxpayers are obliged to register and report their tax obligations to the local tax administration. In Thailand, self-declarations are made to local assessors who assess the self-declared value interms ofhow well it matchestheir data. Self-declarationby landowners is also requiredinthe Philippines once every three years. InBogat$ Colombia, self-assessment has beenrelatively successful inrevisingproperty values closer to their market values and inraisinglocal revenues (see Box 4.1). A recent report recommended extending self- assessmentto rural areas inColombia. 43Brd, RichardM.andEnidSlack (2006). "Taxing LandandPropertyinEmergingEconomies:Raising . Revenue...andMore?" discussionpaper (unpublished),InternationalTax Program, University of Toronto. 51 4.14 The mainrisk o f self-assessment is a tendency towards underestimation o f property values, especially for larger properties. This can result ina regressive tax burden, since lower-values properties generally have a lower rate o f underestimation than higher-valued properties. The best way to guard against underestimation i s public disclosure o f declared values combinedwith an appeals procedure for citizens to challenge values that appear significantly underestimated. Box 4. 1: Self-assessment Self-assessment is an interestingvaluation approachthat was adopted inColombia with the passage of Law 14 of December 18, 1990, which gives municipalities the option to use self-assessment. This system was introducedas a solution to increase the tax base, given the strong pressure against updating assessedvalues, as well as administrative difficulties in undertaking valuations. Self-assessment was in fact proposed as a substitute or supplement to administrative assessment systems and as a transitional mechanism until an effective propertytax administrationis established. Inthose Colombianmunicipalities thathaveadoptedthe self-assessmentsystem (for exampleBogotk), the propertyvalue andthe amount oftax due are determineddirectly by the owner. When the system was first introduced, municipalities hadthe option of establishingaminimum presumptivetax base, to be determined taking into account the property location and area. The self-assessedvalue could not be lower thanthe minimum base times the property area. Inthe absence of aminimum base, the cadastral value could not be lower than the value declared the previousyear plus the inflation rate, or the cadastral value plus the inflation rate. This system was changedfollowing arecessionofthe landmarket andthe drop inreal value o f propertyat the end of the 1990s. Currently, the self-assessedvalues cannot be lower than the cadastral value. To reduce underassessment, the assessedvalue would beusedas the basis for expropriation; however, this has not yet happened. The introduction of self-assessmentas aproperty valuation approach (particularly inBogotk) has beenrelatively successful interms ofraising local revenues. Revenue from the propertytax rose from 300 million dollars in 1992to 900 million the following year afier the introduction of the self-assessmentsystem. Revenuesare currentlyaroundUS$1.2 billionannually. Self-assessmenthas further contributedto the updating of the cadastreregistry and the revision ofproperty values closer to their commercial value. However, arisk of underestimationexists when usinga self-assessmentapproach. Verification processesincluding expert assessments of individual properties, which can be costly, are needed to ensure that properties are not undervalued. A variety of otherjurisdictions also use self-assessment,particularly inIndia. Inthe Indian state of Karnataka, property owners are requiredto make a self-assessmentbasedon publishedtables of construction costs ineach neighborhood.The system inKarnatakawas designedto reducethe corruption and arbitrariness that has accompaniesprofessionalassessments. Bangaloreuses a similar scheme that has evolvedfrom the mass appraisal system of properties.The city of Bangalorehas been classifiedinto six zones based on the property valuationdone by its Departmentof Revenue. Eachproperty is classifiedbased on cost of constructionvalue at currentmarketrate. The tax for a particular property is basedon the annual value ofthe property arrived at by multiplyingaunit area value assignedto the colony/locality by the covered area ofthe property andthe multiplicative factors for occupancy, age, structureand use. These are self-assessedby the propertyholder and entered onto a declarationform. The unit area basedsystem is thus simple to understand, easy to calculateandtransparent. While all of these examples are urban, they demonstrate the feasibility of self-assessmentas atool to rapidly expandthe numberoftax-payingproperties and the valuationofthose properties. Tax rates 4.15 Responsibility for settingthe tax rates, and related local government discretion, vary widely among countries, depending on local conditions and circumstances such as the degree o f decentralization, financing o f local public services, and the availability of 52 other sources of revenues. Rates can be set by the central government44taking into account the local governments needs (e.g., Japan, Chile, Paraguay), or directly by the local government often within limits set by the central government (e.g., Australia, Canada, Spain, Argentina, Colombia andUruguay). Sometimes there is complete local discretion (inthe UnitedStates municipalities are free to set their own rates). Whenrates are determined locally, the rate i s sometimes calculated taking into account the local government expenditure requirements and subtracting revenues from non-property taxes. Inother cases, andespecially where the property tax is the mainlocaltax, the rate is determinedby dividing the municipal budget by the assessmentroll ofthat municipality (UnitedStates). This approach gives greatest autonomy to decentralized local governments, but requires significant levels o f transparency and accountability ontheir part. Italso allows for a closer linkbetweentaxes paid and services received at the local level. However, inthose cases where capacity and transparency at the local level i s lacking, there is an argument infavor o f having the tax rates centrally set, so as to avoid distortions inthe land market or tax competitionamong neighboring municipalities. 4.16 Rates usually vary for differentclasses o f properties or landuses (e.g., residential, commercial, industrial, farms), with lower rates generally appliedto agricultural lands. For example, inCanada, the tax rate on farms and managed forests i s set by law to be 25 percent o f the residential tax rate. Insome cases, progressive tax rates are usedwith higher rates applied as the values ofthe property increases(Argentina, Australia), or when landis left idle. Inother cases, reducedrates are applied incase o fharsh conditions (e.g., inAustralia). Multiple tax rates, however, have shown to be not transparent, as they encourage an artificial division o fproperties to avoid the higher tax rates. 4.17 InLatin American countries tax rates appearto be generally low-especially for agricultural land- compared to OECD countries: they range from 0.3 percent to 4 percent inOECD countries, and from 0.1 percent to 2 percent inLatinAmerican countries. AgriculturaVrural land 4.18 The use of agriculturalhural landproperty taxes is not unique or new. Many countries around the world tax agricultural landand other rural properties. However, when agricultural and forest landis taxed, it is typically done at lower rates or at lower assessed values thanurban land(e.g., inJapanthe value o f farmlandi s fixed at 55 percent o f normal marketvalue; inCanada, the tax rate applied to farms and managed forests is 25 percent o fthe residential tax rate). Inaddition, farmland i s often assessedat its value incurrent use, that is considering that itwereto continue to be usedas a farm, rather than at its highest and best use. However, agricultural lands inthe urbanizationareas tendto be assessed as ifthe lands were residential lands. 4.19 Other tax-related incentives givento agricultural landsinclude exemptions o f some properties such as farm buildings and residences, rebates by provincial governments, tax deferrals, and concessionsto dispose o f farmland inorder to encourage 44Infederal states, generally rates are set at the "State" level (Province not Federal level). 53 agricultural landtransfers, especially inthe case o f intergenerational ones withinthe same family (Japan). Insome cases, farmland (especially o f very low value) is exempt from property taxation. 4.20 Despite the widespread practice o f giving preferential treatment to agricultural lands, tax exemptions or reliefare not alwaysjustified from an economic and social point o f view. They tend to create distortions inthe taxation system, and are often difficult to administer. They further cause the agricultural landprice to increase, thereby making landaccess more difficult for new farmers, and favor speculation at the urbanfringe. 4.21 However, tax exemptions or relief can bejustified for environmental protection andmanagement purposes. Some countries have introduced incentives including a waiver of landtaxes to establish private protected areas (e.g., Brazil and Paraguay),45 while other have exemptedforest landfrom taxation (Uruguay). Similarly, tax relief appears sensible inthe case o f small/poor landholders. For example, inChile a minimum threshold has been established, whereby properties less than2 hectares are permittedto pay an alternative small lump sum amount annually. 4.22 Taxation o f agriculture landbasedon objective measures such as land productivity i s usedinLatinAmerica andhas beenfairly successful at collecting revenues. For example, inUruguay the rural land tax i s set as a presumptivenet income tax, where the land cadastral value (which i s the basis o f assessment) i s calculated taking into account the land productivity index set by the National Commission for LandAgro- economic Studies (CONEAT), as well as proximity to main transportation networks and urban centers. However, this systemrequires a fairly sophisticated set o f records, including inputs costs. 4.23 Eachuniform piece o f land i s assigneda "pure" Coneat index, according to its soil quality. A landparcel may be formed by several smaller pieces with different Coneat indexes each. The overall Average Coneat Indexwill be the result o f calculating the weightedaverage o f all the pieces withinthe whole land. This average index is an indicator o fthe landproductivity taken as a whole. Tax administration 4.24 Responsibilityfor assessment does not seem to follow a specific trend and falls either on the central or local level government. Differences inthe degree o f managerial and administrative capacity at the centralhegional and municipal level affect the efficiency o f the periodic adjustments o f the assessments. Responsibility for collection, however, i s usually a local government function, giventhe incentives at the local level for effective collection to finance local services. Ifthe local government lacks the capacity, 45Paraguay's existing legislation providespropertytax relief for several categories of ecologicalareas. The basic propertytax legislation (Ley 125191) exonerates protectedwild areas (6reas silvestres protegidus) that are declared as suchby law. The law on protectedwild areas (Ley 352/94) providesthat private wild areas establishedby Executive Decree can also receive exemptionfrom the property tax, ifso mentionedinthe Decree. The law onreforestation(Ley 536/95) provides a 50 percentreduction inproperty tax for reforested areas that have beencertified as suchby the National Forest Service. The main lacunainthe above legislation appearsto be for natural forests that have not beendesignated as protectedwild areas. 54 tax collection services are thenprovided by the central government (e.g., inmany Latin American countries the service appears to be carried out at the regional or central level). Somegoodpractices 4.25 A numbero flessonsand best practices useful for the development of a property taxation system inParaguay can be drawn from the international experience: 0 Marketvalue assessment,basedona developed cadastral system, periodic reassessments, and an appeal process with transparent procedures, i s the recommended assessment method. It i s a fair and transparentway to apportion taxes among properties, and adequately reflects all factors determiningthe value o f the property (land quality/productivity, public infrastructure, etc.). 0 However, where a complete cadastral systemi s not yet available, it i s preferable to build up the listing o fproperties and expand the tax base inalternative ways, rather than wait to have a full, official cadastral system, which can be completed at a later stage. The international experience suggests the use o f alternative, less rigorous methods for completingthe tax base. Self-assessment can be an effective substitute or supplementto administrative assessmentsystems and serve as atransitional mechanism untilan effective property tax administration i s established. InLatin American countries, the property tax has a fair revenue-raising potential, but to reachthe potential, the transfer o f technologies andthe strengtheningo f capacity to identify properties and assess their value i s a key element. Self-assessmenti s a low cost approach compared to cadastral parcel by parcel valuation and it involves lower risk o f appeal. It i s an effective solution to increase the tax base when there is strong pressure against updating assessedvalues, as well as administrative difficulties inundertaking valuations. Self-assessmentmay be combined with area-basedassessment, whereby a minimumtax base i s established according to the property size and then adjusted by the self-assessed value. 0 Goodpractice suggests giving local governments discretion on settingthe tax base andthe tax rates, thereby creating a transparent link betweenthe tax and deliveryo f local public services. Incountries with weak administrative systems like Paraguay, however, setting a uniform tax rate at the central level appears justified inorder to avoid distortions inlandmarkets and/or to avoid tax competitionbetweenneighboringmunicipalities. Inthis regard, the existing legislationinParaguay that sets a uniform 1percent tax rate appears appropriate. 0 Tax exemptions and relief are not generally justified inthe case o f agricultural lands. However, some form o ftemporary reliefmay be appropriate for beneficiaries o f agrarian reform programs. Similarly, tax exemptions can provide an effective tool for protectingand managing environment and natural resources. 55 Chapter V: Conclusionsand Policy Options 5.1 The preceding chapters analyzed the concentration o f landholdings inParaguay, the strengths andweaknesses o fthe existing property tax legislation, the state o f municipal finances, the gap between fiscal and market values o f rural landinCaaguazu, the potential revenue gains from switching the property tax base from fiscal to market values, the stimulative effects on production and landmarkets o f a meaningfultax on rural land, and international best practices concerning how to structure such a tax. 5.2 This chapter summarizes the main findings o f the preceding analysis and propQses various policy options for improving the property tax system inParaguay. Core Findings of the Report 5.3 The principal findings o fthe report canbe summarized as follows: a) There is a very highconcentration o f land ownership inParaguay, due to historical conditions inthe 1gthcentury and to the previous program o f agrarian "reform," which aimed more at opening up and settling the interior with generous land allocations than at providing a small but viable landplot to all landless. The era o f extensive public lands available for distribution (tierrusfiscales) has ended, however, and the new program o f agrarian reform (post-2000) has to purchase land at market prices for distribution, which limits its coverage and effectiveness. b) A considerable array of evidence points to significant underutilization o f land. This evidence includes the highpercentage o f landdevoted to extensive cattle ranching, evidence that the productivity o f small farms i s higherthan large farms (when controlled for accessto capital), and the absence o f significant tax revenues from rural land, which permits underutilizedlandto be heldwithout cost. c) The existingproperty tax law i s basically sound and incorporates many desirable features when compared with international experience, including allocation o f property tax revenues to the municipalities, a basic tax rate o f 1percent, the non- taxation o f improvements on rural land, and reasonable exclusions including exemptions / reductions for designated ecological areas and reforestation. Some adjustments would nevertheless be desirable, including elimination o f "progressive" rates on large holdings and creation o f an additional exemption for sustainably- managednatural forests. d) The major feature ofthe property tax law that impedesit from being a meaningful instrumentoftax policy is the basing ofthe tax assessmenton fiscal values that are an abnormally low percentage o f market values (on average, 1.8 percent for rural land in Caaguazu). Although these fiscal values have beenadjusted annually duringthe past decade, they do not reflect the actual and constantly changing marketvalues o f rural landthat have resulted from the soy boom and rapidly growing cattle ranching, among other factors. Moreover, the property tax law effectively locks-in the undervaluation o f landby prohibiting increases infiscal values inexcess o f inflation. 56 An amendment to this provision ofthe property tax law would be requiredinorder to make it a meaningfultax policy instrument. e) Given the limitedcapacity inParaguay for updating fiscal values to reflect the actual and constantly changing marketvalues o f land, as well as the high cost and long timeframe requiredto establish a nation-wide international experience indicates that a self-assessmentsystem couldbe a viable alternative, especially if supplemented with full public disclosure ofthe self-assessedvalues and an appropriate challenge mechanism. The introduction o f publicly disclosed, self- assessedmarket values as the basefor property taxation would incorporate the innovative features o fthe previously proposed but un-enacted legislation for creation o f a tax on rural wealth. f, The revenue potentialof ameaningfulproperty tax onrurallandis considerable. An illustrative calculation basedon official (BNF/SNC) estimates o f market values and the existingtax rate of 1percent indicates that for Paraguay as a whole, the property tax from rural land could generate about US$lOO millionper annum, or 1.1percent of GDP. This estimate i s illustrative yet conservative, inview o f a much higher estimate that this report derived for the average value o f rural land inCaaguaz6 thanthe official estimate (US$1182 versus US$863 per hectare). g) The generation o f property tax revenues from rural lando fthe above magnitude would double the resources currently available to municipalities o fthe interior and represent an important step towards greater fiscal decentralization. International experience indicates that locally generatedrevenues, such as the property tax, lead to greater identificationbetweenthe taxpayer andthe provision o f services financed withthese revenues, leading to avirtuous circle of better expenditureallocation and greater citizen control. h) The financial administration capacity ofthe municipalitiesofthe interior appearsto be weak and needs to be upgradedsubstantially ifthe municipalities are to become effective agents o f fiscal decentralization. Management and collection of the property tax is especially weak, but all areas o f financial administrationappear to need improvement, including planning, budgeting, expenditure control and preparation o f investmentprojects. Evenwithout increasesinproperty tax revenues, it would make sense to upgrade the financial administration capacity o f the municipalities in order to make effective use o f the growing stream o f royalties. i)Internationalexperienceindicatesthatthepositivenon-revenueeffectsofamore effective rural landtax are likely to improve other long-term development issues in Paraguay, namely, the underutilizationo f agricultural land, excessive land concentration and the cost o f financing the existing agrarian reform program. This i s becausehigher landtaxes act as an incentive to allocate landto its most productive use and/or to sell or rent land for which the owner does not have the technical or capital resources neededto improve the utilization o f his property. 46A World Bankproject,LandUse Rationalization(Loan 3445-PA), financedthe surveyingof 2 million hectaresinItapuaandAlto Paranain2000 at a cost ofUS$l1million. 57 5.4 The following sections propose various policy options for improving the property tax systeminParaguay with a view to: 0 Makingthe existingproperty tax aneffective policy instrumentfor achieving better landuse and generating higher local tax revenues to finance a greater degree o f fiscal decentralization; 0 Strengthening financial administration inthe municipalities, which needsto be done inany case to make effective use o f increasing royalties; and 0 Identifying the linkages betweena more effective landtax and existing program of agrarian reform. Options for Makingthe PropertyTax an EffectiveRevenueInstrument 5.5 As discussedinChapter 1,the major shortcoming ofthe existing property tax is the low fiscal values that are used for tax assessment. International bestpractice indicates that fiscal values inParaguay should be adjusted to market values. One option for doing so would be to expand the SNC's capacity to assess the market value o f all properties inParaguay. This would require, however, the creation o f a full national cadastre, which would be a long and expensive exercise. It would also requirea significant expansion inthe capacity and annual budgeto fthe SNC to maintainupdated market values for the country as a whole. 5.6 A secondoptionwould be to delegatethe SNC's authority to set fiscal values to the individual municipalities, the larger ofwhich might be able to develop a full cadastre for their respective municipality more quickly than waiting for the SNC to do so. This option would perhaps be less time-consuming insome municipalities, butwould likely be equally or more costly interms o f creating moderncadastres and assessmentcapacity in each municipality. Under either option, the existing property tax law would have to be amendedto change the tax base from fiscal to market values and to eliminate the provision for capping annual increases inassessedvalues to the rate o f inflation. 5.7 A third option would beto amend the existing property tax law to require an annual self-assessment o f market value - one o f the innovative features proposed inthe draft legislationfor creation o f a new tax on rural wealth (Box 1.2). A self-assessment systemwould have the major advantage of developing a market value tax base quickly without the delay and expense o f creating a full national cadastre. Eachmunicipality currently has a "fiscal" cadastre, which i s a simplelist o f properties by square and lot number (padrony$nca) and could serve as the base for recording self-assessed declarations o f marketvalue. Such self-assessments should more easily capture changing land marketconditions than a formal cadastre system. Self-assessmentshould also avoid the political resistance created eachtime the government adjusts the tax base, becausethe owner himselfwould propose the property value rather than having it imposed from above by government decree. 58 5.8 The major features o f a self-assessment process could include: 0 An annual sworn declaration (declaracidnjurada) ofthe market value of each rural property. A similar legal instrument already exists inParaguay as part o f the newpersonal income tax inwhich individualsmustdeclare their income and assets. 0 A phase-in of the self-assessment requirement, starting with the largest properties, inorder to accompany an orderly growthinthe administrative capacity o fthe municipalities. For example, inthe first year, properties larger than 300 hectares inthe EasternRegionandlarger than 1000hectaresinthe Chaco couldbe required to file a self assessment, thus limitingthe initial number o f filings to about 7,000 (see Appendix Table 1). A five or six year phase-in period would probably be requiredto allow sufficient time for municipalities with many small properties to increase their capacity to process and administer the self-assessment system and attain 100percent coverage (about 325,000 properties for Paraguay as a whole). Duringthe phase-in period, properties not yet requiredto file a self- assessment could continue to be governed by the existing fiscal values system. 0 Public disclosure o f the self-assessed values, inorder to provide the basis for public control and comparison o f property values. Each municipality could disclose the self-assessments received, at first via hardcopy publication and eventually on the internet.47 0 Establishment o f a mechanism for public contest and appeal o f missingand under-assessed properties. A committee at the departmental level could be established to receive complaints with the power to adjust self-assessments that are determined to be significantly undervalued. Such a committee could be similar to the proposed Valuation Review Committee (Junta de Avalzio) inthe proposed rural wealth tax (see Box 1.2)- Inthis regard, the SNC could provide valuable assistance inthe form o f estimates o f minimumand average market values for each district, which would serve as a reference point for evaluating disputes over the self-assessment o f a particular property. 0 Incentives to encourage assessments as close as possible to market values, e.g., amendment to the law limitingthe value o f a mortgage on a property to the self- assessedvalue inthe previous tax year. 0 Penalties for non-compliance with making a self-assessment, e.g., automatic assessment by the Junta de Avaldo at a value equal to the district's average self- declared value plus 50 percent. 0 Self-assessment o f rural properties should be basedonly on the site value o f the land, as currently stipulated inLey 125/91,and not on farm improvements in order not to discourage investment inproduction. The principle o f not taxing improvements inthe urban areas could be studied separately. 47Public disclosure of assessment values is best practiceand commoninOECD countries. For example, property assessment values inWashingtonDC canbe accessedvia internet at the following address: https://www.taxpayerservicecenter.com/RP-Search.jsp?search-type=Assessment 59 5.9 Regarding the property tax e,theexistingrate o f one percent appears reasonable(about average for Latin America, although low compared with OECD countries). However, giventhat movement to full market values could imply a significant increase inactual tax liabilities (e.g., a 54 times increase inthe case of Caaguazc), a tax rate adiustment period could be considered to phase-in the increasedtax burdenonproperties subject to self-assessment. For example, the tax rate applicable to self-assessedproperties could be lowered to 0.1 percent for the first year and rise by 0.1 percent each year to the full one percent by year 10. Properties not yet subject to self assessmentcould continue to pay the full one percent rate on the current fiscal value. 5.10 With a market oriented self-assessment system, multipletax rates couldbe eliminated, inorder to avoid creating strong incentives for the artificial division o f properties as the new assessment systemtakes effect and the tax burdenbegins to bite. The multipletax rates that could be eliminated are (i) additionaltax on large the properties and latifundios (adicional a inmuebles de gran extensidny latifundios), which does not produce any significant additional tax revenue at present (para.1.35), and (ii) the 0.5 percent rate for properties less than 5 hectares, since many small agricultural properties near urbancenters are among the most efficient producers and do not need a tax subsidy. 5.11 Regarding tax exemptions, elimination o f the exemption for properties owned by political parties and private sports clubs could be considered, as these benefit specific groups rather than the population at large. The current five-year exemption for beneficiaries o f the agrarian reform (once they receive title to their land) could be maintained, butthe law could be changedto provide immediate titling without cost to the beneficiary to encourage investmentinthe property from the beginningand to bringthe beneficiary onto the property tax roll as soon as possible. The cost o f providing free title would likely be more than recovered earlier payment o f property taxes. 5.12 Inview ofthe widespread deforestationthat has occurred over the past fifty years, a new exemption for natural forests that are managed ina sustainable manner could be considered. An appropriate criterion for the exemption would be that the owner obtain andmaintain ingood standing a certificate of sustainable forest management from a private certification service (of which there are several working inParaguay). A three year grace period could be provided to allow owners to obtain such certificates. With or without such an exemption, owners o f natural forests should nevertheless be requiredto file an annual self-assessmento f their property's market value, inorder to keep the fiscal cadastrescomplete. 5.13 ,Finally, an amendedproperty tax law should empower municipalities to seize and auction properties for which the property tax has not beenpaid for two years. Such powers are common features o fproperty tax systems inother countries and are a necessary mechanism to ensure full compliance. 60 Optionsfor StrengtheningMunicipalFinanceAdministration and PropertyTax Collection 5.14 Whilethe municipalities are constitutionally autonomous and responsible for their own financial administration, the central government and the nation have a vested interest inthe sound administration ofthe municipalitiesand, inparticular, inthe efficient implementation o f the property tax which remains governed by national legislation. For the property tax to exert its desirable impacts on agriculturalproduction andland distribution, tax policy needsto be implementeduniformly across the country. Also, the transfer o f royalty payments i s increasing quickly and the municipalities need to improve their financial administration urgentlyto managetheseresourcesmore effectively. 5.15 For these reasons, this report suggestscreating a nationalprogram o ftechnical assistancewith the aim o f upgrading the financial administration o f all municipalities to minimumnational standards by 2010. The administration of such aprogramoftechnical assistanceby the Ministry o f Hacienda would be consistent with its mandate inthe Law on Municipalities4*to establish the technical norms for budgeting, accounting and treasury management (financial administration ingeneral) to be used by the municipalities. 5.16 Inbroad terms, aprogramto strengthenmunicipal finances couldincludethe settingof uniform standards, the upgrading of accounting and information systems, and the training ofhuman resources inthe municipalities. More detailed elements could include: 0 Establishing a standardized chart o f accounts consistent with those usedby the central government. There i s currently great variation inthe charts o f accounts usedamong municipalities, and betweenthose at the local and central levels, in particular, the definition o f financing items and the overall surplus/deficit. 0 Developing standardized and appropriate software for financial administration that would facilitate the flow o f information, improve expenditure control and increase processing speed and accuracy. Many municipalities currently have no integrated software and make do by using simple spreadsheetsfor each separate part o fthe financial management cycle. These then needto be reconciled and consolidated. Inparticular, there i s a needto link taxpayer informationwith tax collection data, e.g., collection o fproperty taxes (caja)with tax assessments (cadastrejscal). 0 Over time, further steps could be taken to incorporate the key steps o fthe financial management cycle (budget preparation, execution, monitoring) into a standard database usingsoftware that would facilitate the flow o f information withinthe municipality and ensure adequateand timely reportingto Hacienda and the Comptroller General. 4gLey OrganicaMunicipal 1294f87. 61 Training o f financial management staff: lack o f humanresources i s currently one o fthe key constraints inincreasing tax collections. Core training programs could be developed and contracted to localuniversities. Establishing capacity for managing the fiscal cadastre, inparticular, the steps neededto accompany the introductionof a self-assessment systemfor property values. Inthis regard, consideration could be givento establishing property tax assessmentcapacity at the department level, since valuation assessment andthe monitoring o f market values o f land i s a higher level technical specialty than the billing and collection o fproperty taxes, which each municipality would most likely wishto keep withinits own control. A departmental level valuation capacity would also be consistent with the idea o fthe departmental appeal procedure (JuntadeAvaWo) mentioned inthe preceding section. Strengthening compliance with reporting requirements: sanctions could be usedto enforce regular and accurate reporting to the Auditor General and the Ministry o f Finance.49Public disclosure o f municipal budgetsand budget execution should be promotedvia the government gazette, newspapers or on the internet. Mobilizing public support for stronger financial accountability: a public relations campaign to help citizens understand municipal finances and the services to expect from their taxes, and to create demand for improved disclosure and accountability. Inthis regard, civil society organizations that specialize inbudget transparency could play an important supporting role. 5.17 At the same time, reforms ofthe intergovernmental fiscal systemcould improve the incentives for local governments to increasetax collection efforts. Currently, the reliance on royalties for a large share o f municipal income discourages the mobilization o f own source revenues, which are politically less popular. However, inorder to strengthen accountability and reap the benefits o f decentralization, a significant share of expenditures (especially those for locally consumed services) should be financed by locally raised taxes. Inorder to avoid the "moral hazard" problem o f dependence on royalties, the transfer of royalties could be made conditional upon the municipalities meeting certain financial management standards and specified targets for property tax collections. 5.18 Finally, it would be useful to develop amore comprehensive andpro-business / growth-oriented vision o f municipal tax policy. At present, the municipalities tax dozens o f activities, such as plans for construction, division o f properties, publicity, entertainment, games o f chance, public transport, slaughter o f animals, cemeteries, etc., all of which raise minor amounts o f revenue, With the advent o f a more significant property tax, it would make sense to eliminate many o f these "nuisance" taxes and concentrate tax collection efforts on a few major items, such as property, vehicles and perhaps commercial / professional licenses. 49At present, the Ministryo f Finance issues "certificates o f compliance" to municipalities that have submitted adequate reports on their finances, but the possibility o f imposing actual sanctions could promote hller compliance especially ifnew uniform accounting standards and financial administration systems are adopted. 62 Reflections on Land Tax Policy andLand Distribution to the Poor 5.19 To conclude, a few reflections on the linkages between a more effective landtax policy and the existing program of agrarian reform. As discussed inChapter 3, the stimulative effects o f a land tax act mainly onproduction, which inturn should leadto higher demand for rural labor and employment for the rural poor. A significant landtax should also lead to some redistributiono f landfrom large and mediumsize farms to more efficient and well capitalized mediumand smaller farms. Such redistribution should occur naturally through the market reflecting the pressureso f the tax on the owners o f underutilized landto invest and produce more inorder to afford the tax, or to sell their properties to farmers who can. Ineither case, there would be greater demand for rural labor and employment for the rural poor. 5.20 This natural redistributionwill not directly put more landinto the handso fthe landless and rural poor, but it will make more land available to the market and, as such, should lead to lower landprices (see Table 3.3 for an example o f how the landtax acts on the marketprice of land). Lower landprices would facilitate the existing programof agrarianreform which, given the scarcity o f fiscal lands, relies on the purchase o f land from private owners. The landtax would thus lower the cost o f agrarian reform and increasethe number o f landless that the govement could settle innew colonies for the same amount o fbudget. 5.21 A significant landtax, suchas the one suggestedinthis report of one percent on the full marketvalue of land, would also act to address some ofthe past injustices ofthe former program o f agrarian reform which distributedlarge amounts o f landto relatively few people (see Box 1.1). Trying to recover these tierras malhabidas would be a long, costly and contentious legal process. Instead, society could recover some o f the economic rent from these lands via an effective land tax and use the proceeds to finance social services and infrastructure inthe rural areas. An effective landtax would thus provide some "social justice" to the excesses o f the past. 5.22 Finally, it is noteworthy that some countries have faced similar landdistribution problems as does Paraguay today and are addressing these problems via a landtax. An example i s Namibia, whose program aims to finance land distribution with the proceeds o f a temporary landtax. This is a differentvision than that set forth inthis report which views the property tax inParaguay as apermanent source of revenuefor local expenditures ingeneral. Also, inParaguay, one-half o fthe revenues from the new agricultural income tax (IMAGRO, described inBox 1.3) are destinedto finance the agrarian reform program. 5.23 Nevertheless, Namibia's land tax incorporates many o f the same principles and features as suggestedinthis report, for example, the use o f self-assessments, market values and a similar tax rate. It i s also basedon the same economic principles, namely, the stimulative effect ofthe tax onproductionandthe moderating effect ofthe tax on landprices. Most of all, it is noteworthy that Namibiamobilized a national political consensus to create a new landtax, which suggeststhat such changes inlandtax policies are administratively feasible and can be implementedina developing country context. 63 Appendix Table 1: Number and Area of Farms in Paraguay, by Farm Size, 1991 Eastern Region Western Region Paraguay (Chaco) Total Number of Size Number of Size Number of Size Farm Size Farms Hectares Farms Hectares Farms Hectares Total 300,523 11,428,750 6,698 12,388,991 307,221 23,817,741 Without area 7,610 0 352 0 7,962 352 Less than 1ha. 21,872 8,461 105 37 21,977 8,498 From 1 to 5 has. 92,392 221,s14 419 988 92,811 222,802 From 5 to 10 has. 66,364 429,115 241 1,544 66,605 430,659 From 10to 20 has. 803,183 291 3,620 66,223 806,803 From 20 to 50 has. 3 1,095 845,103 424 12,807 31,519 857,910 From 50 to 100has. 7,007 464,073 570 38,576 7,577 502,649 From 100to 200 has. 3,383 449,376 896 119,793 4,279 569,169 From 200 to 500 has. 2,2271 663,455 1,276 386,580 3,503 1,050,035 From 500 to 1.000 has. 396,354 1,525 1,010,953 From 1.000to 5.000has. 2,838,461 2,143,979 2,356 4,982,440 From5.000to 10.000has. 1,657,600 1,987,273 533 3,644,873 10.000andmorehas. 2,433,510 237 7,297,440 351 9,730,950 By Group 1/ Small 254,170 1,462,573 2,402 57,572 256,572 1,520,145 Medium 41,485 1,758,552 2,770 902,727 44,255 2,661,279 Large 4,868 8,207,625 1,526 11,428,692 6,394 19,636,317 Small 84 6 Medium 14 11 Large 2 82 Average Average Average Definition of Groups Has. Size Has. Size Size Small <20 6 < 100 24 Combined 6 Medium 20-300 42 100-1500 326 Combined 60 Large >300 1686 >1500 7489 Combined 3071 Fuente: UAG, Censo Agropecuario Nacional, 1991andstaffestimates. 1/ Definitionso f farm size per the newAgriculturalIncomeTax (Imagro), 2004. The category "medium" doesn't coincide exactly withthe categoriesofthe 1991Census. 64 Appendix Table 2: Key MunicipalTax and Expenditure Ratios, 1999-2005 (inpercent of GDP) 1999 2000 2001 2002 2003 2004 2009 Total Revenues 1.45 1.55 1.63 1.60 1.49 2.08 Asuncion 0.65 0.68 0.68 0.58 0.5 1 0.49 0.95 Interior 0.81 0.87 0.94 1.02 0.98 1.13 Tax Revenues 0.87 0.90 0.87 0.84 0.82 1.24 Asuncion 0.36 0.38 0.39 0.35 0.34 0.29 0.88 Interior 0.5 1 0.51 0.49 0.49 0.48 0.36 Property Taxes 0.36 0.39 0.40 0.39 0.39 Asuncion 0.18 0.19 0.19 0.18 0.17 0.15 Interior 0.19 0.20 0.21 0.21 0.22 Non-Tax Revenues 0.53 0.52 0.50 0.44 0.39 0.32 Asuncion 0.28 0.29 0.28 0.21 0.16 0.18 0.04 Interior 0.25 0.24 0.22 0.22 0.23 0.28 Royalties 0.00 0.05 0.18 0.25 0.23 0.52 Asuncion 0.00 0.00 0.00 0.00 0.01 0.01 0.03 Interior 0.00 0.05 0.18 0.25 0.22 0.49 Capital Revenues 0.05 0.08 0.07 0.08 0.05 Asunci6n 0.01 0.01 0.01 0.01 0.00 0.00 Interior 0.05 0.06 0.06 0.06 0.05 Total Expenditures 1.34 1.44 1.57 1.53 1.36 1.87 Asunci6n 0.58 0.65 0.68 0.61 0.50 0.51 0.85 Interior 0.76 0.80 0.90 0.92 0.86 1.02 Capital Expenditures 0.17 0.23 0.30 0.30 0.24 Asuncion 0.04 0.08 0.06 0.06 0.03 0.03 Interior 0.13 0.15 0.24 0.24 0.21 _ _ _ _ _ _ _ _ _ _ _as_percentof _ - - revenues - - - - - - - - - - - - - - . - _ _ _ Surplus/Deficit 16 14 6 4 15 10 Asunci6n 11 6 1 -6 3 -5 10 Interior 5 8 5 10 11 10 Interior= 222 Municipalities of the Interior Note: Inthis table, royaltiesincludebothcurrent royalties, which are accountedunder non-tax revenues, and capitalroyalties, which are accountedunder capitalrevenues. See Annex tables A3.3, A3.4 and A3.5 for underlyingdatainGuaranies. 2005" Note:Datafor 2005 is drawn from Ministry ofHacienda, InformeFinancier02005, which is adifferentsource - than data for all other years and maynot be consistentwith data for previous years. See Chapter 1, Overviewof MunicipalFinancesfor more detailed commenton 2005 data. 65 2000 2001 2002 2003 2004 2005 Tax Revenues Profit tax 478 459 585 624 880 967 VAT 1150 1204 1253 1570 1939 2372 Excise taxes 435 574 531 704 1004 1007 Customstaxes 488 499 488 665 904 843 Gov't pensionfind I/ 300 313 340 369 440 541 Other taxes 126 115 64 113 202 282 Total Tax Revenue 2/ 2977 3164 3261 4045 5369 6012 Non Tax Revenues Royalties(Itaipd Yacyreta) - 781 1284 1259 1492 1643 1651 Other 31 490 527 560 530 638 756 Total Non Tax Revenue 1271 1811 1819 2022 2281 2407 T O T A L REVENUES2/ 4248 4975 5080 6067 7650 8419 Tax Revenues Profit tax 1.9 1.7 2.0 1.7 2.1 2.1 VAT 4.6 4.5 4.3 4.4 4.7 5.1 Excisetaxes 1.8 2.2 1.8 2.0 2.4 2.2 Customstaxes 2.0 1.9 1.7 1.9 2.2 1.8 Gov't pensionfind I/ 1.2 1.2 1.2 1.o 1.1 1.2 Other taxes 0.5 0.4 0.2 0.3 0.5 0.6 Total Tax Revenue 2/ 12.0 12.0 11.2 11.3 12.9 13.0 Non Tax Revenues Royalties(Itaipd - Yacyreta) 3.2 4.9 4.3 4.2 4.0 3.6 Other 31 2.0 2.0 1.9 1.5 1.5 1.6 Total Non Tax Revenue 5.1 6.8 6.2 5.7 5.5 5.2 T O T A L REVENUES21 17.2 18.8 17.5 17.0 18.4 18.2 Gross Domestic Product 24737 26466 29105 35666 41522 46135 11Classifiedunder Non Tax Revenues by Ministry of Hacienda. 21Excludes private sector contributions to national pension and health insurance scheme (IPS), equivalentto 2.2% in2000 and 2.1% in2002. 3/ Includesfees, interest received, transfers from public entities and externalgrants. Source: Mininstry of HaciendaInforme Situaci6nFinancierade laAdministracibn Central (200012005). 66 67 68 69 Appendix Table 5: Caaguazu Market value of INDERTlands, indigenouslands and forests, - by district District Hectares Total value ValuCpSS (Guaranies) per hectare) INDERT lands Caaguazu 59,662 63,297,254 ,061 Carayao 3,058 1,101,975 360 Cecilio Baez 9,755 3,60 1,855 369 Coronel Oviedo 52,210 33,984,359 651 Jose Eulogio Estigarribia 77 152,569 ,969 Juan Manuel Frutos 22,108 29,344,15 1 ,327 Nueva Londres 7,962 3,443,091 432 RI3 Corrales 29,528 15,109,046 512 Rad1Arsenio Oviedo 1,711 2,784,722 1,628 Repatriacih 65,117 75,356,361 1,157 San Joaquin 30,263 13,816,117 457 San Jose de 10s Arroyos 20,493 7,591,889 370 Sim6n Bolivar 31 14,275 456 Yhu 44,639 52,423,375 1,174 302,021,039 871 Caaguazu 150 122,442 816 Jose Eulogio Estigarribia 1,143 2,616,234 2,290 Juan Manuel Frutos 47 43,982 943 MariscalL6pez 518 902,915 1,744 Raul Arsenio Oviedo 2,129 3,764,949 1,769 Repatriaci6n 2,897 4,294,502 1,482 RI3 Corrales 128 40,308 316 San Joaquin 10 3,319 340 Vaqueria 210 381,998 1,815 YhU 2.747 2.272.754 , , 827 Total/average 9,977 I 14,443,402 I 1,448 2,069 1,035,760 501 Carayao 27,368 10,725,388 392 Coronel Oviedo 21,958 10,864,967 495 La Pastora 2,322 849,7 10 366 Nueva Londres 1,489 695,573 467 RI3 Corrales 2,372 1,462,765 617 San Joaquin 6,117 1,877,392 307 San Jose de 10s Arroyos 3,643 1,294,434 355 Santa Rosa del Mbutuy 234 102,597 439 Sim6n Bolivar 3,496 1,375,532 393 Yhu 76 58,100 761 Totauaverage 71,145 II 30,342,2 19 426 70 .-a,EEa n v1 5.- E v 'a a 3 M 6.-exm a Y YA & ea 3 E2 c,a, - h ._ --._8 20 8 3 m UE u U0 ma -E m a a U Y.. \o cz.- u X 'El 22 .-5* a L 71 TTI T I .!sc 3 E - Bibliography Alegre Sasiain, Diputado Efrain, "Distribucidn de la tierra en el Paraguay destinadaa la reforma agrariaperiodo 1950-2000", Investigacion (not published). 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