The Economic Impact of a Rural Land Tax on Selected Commercial Farms in KwaZuluNatal KZN

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• The Economic Impact of a Rural Land Tax on
  Selected Commercial Farms in KwaZulu-Natal (KZN)
• By
• MAG Darroch, RB Lee GF Ortmann

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Contents

• Introduction
• Key provisions in the Local Government Municipal
  Property Rates Act (LGMPRA) No. 6 of 2004
• Proposed Department Provincial Local
  Government (DPLG) land tax rebates
• Economic Effects of a Land Tax
• Research Methodology
• Results
• Conclusions Recommendations

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Introduction

• 15 Drafts of the Local Government Property Rates
  Bill
• LGMPRA No. 6 of 2004 signed into effect on 2 July
  2005
• Power for SA Municipalities to tax land stems
  from Section 229 of the South African (SA)
  Constitution
• No peer-reviewed published study on the effects
  of a land tax using accounting economic data
  for individual SA commercial farms

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Introduction (contd)

• Aim of the study
• Estimate the potential economic impact of a land
  tax on selected commercial farms in KZN
• Residual Income Methodology (RIM)
• Estimate economic profit (proxy for the annual
  return to risk land) available to pay the land
  tax
• Economic profit Revenue - accounting costs -
  income tax - charge for the opportunity cost (OC)
  of management

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Key Provisions in the LGMPRA

• Municipal Valuers Method of Property Valuation
• Every municipality must designate a person as a
  municipal valuer
• Valuer must determine a market value for all
  properties within that municipality, and list
  them on a valuation roll
• Section 46(1) of the LGMPRA defines market
  value

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Key Provisions (contd)

• .the amount the property would have realized if
  sold on the date of valuation in the open market
  by a willing seller to a willing buyer.
• .for agric purposes, the value of any annual
  crops or growing timber on the property that have
  not yet been harvested at the date of valuation
  must be disregarded.
• Land tax thus falls on the improved value of farm
  land!

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Key Provisions (contd)

• Determination of the Land Tax Rate
• Farm property tax the market value of immovable
  property x a Cent amount in the Rand (rate
  randage) that a municipal council determines
• Each municipality will apparently set the rate
  randage to meet its needs, taking into account
  the likely impact on local economic development,
  ratepayers and their ability to pay such rates

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Key Provisions (contd)

• Relevant checks balances (Section 16(2)(a))
• If a land tax rate is materially and
  unreasonably prejudicing
• (a) national economic policies (b) economic
  activities across municipal boundaries or (c)
  the national mobility of goods, services
  capital
• The Minister for PLG may, after informing
  Minister of Finance, gazette a limit to the rate
  randage. Farm evidence?

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Key Provisions (contd)

• Compulsory Phasing-in of Certain Rates (Section
  21)
• Newly rateable property phasing-in discount
• Year 1 75 Year 2 50 Year 3 25 Year 4
  Full rate applies
• Rate Exemptions, Rebates Reductions (Section
  15(2)(f)
• Bona fide farmers
• LGMPRA does not specify, but DPLG has published
  guidelines

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Proposed DPLG Guidelines for Land Tax Rebates

• Extent of Municipal Services Provided to Agric
  Properties
• 7.5 rebate if no municipal roads next to the
  property
• 7.5 rebate if no municipal sewerage removal
• 7.5 rebate if no municipal electricity
• 20 rebate if water is not supplied
• 7.5 rebate if no municipal refuse removal

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DPLG Guidelines (contd)

• Contribution of Agric to the Local Economy
• Up to 5 rebate if substantial job creation and
  salaries/wages are reasonable (e.g., meet minimum
  wage or industry average)
• Extent to which Agric Assists in Meeting Service
  Delivery and Development Obligations
• 5 if farm owner provides permanent residential
  property
• 5 if such residences are provided with potable
  water
• 5 if the farmer provides electricity
• 5 if the farmer provides land/buildings for a
  school, cemetery or recreational purposes.

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Economic Effects of a Land Tax on Improved Farm
Land

• Reduces land rents (annual return to land) ?
  disincentive to investment in future improvements
  (Pasour (1973))
• Unlikely to bring idle land into production
• Additional fixed cost!

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Economic Effects (contd)

• Land tax capitalized into lower land values
  (Pasour 1973 1975)
• Growth stock model (Barry et al., 2000) shows
  that R0 (annual land rent) is a constant of V0
  (market value of land) R0/V0
• ? Land values are expected to fall by the same
  as land rents if a land tax is fully capitalized!
• RIM must show the negative effect of a land tax
  on land rents!

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Research Methodology

• Five case-study commercial farms in KZN
• Well-established (operating for over 10 years)
• Accurate and audited accounting data for 5 years
  since 2001
• Typical KZN farm enterprises in Mtonjaneni and
  uMngeni municipalities (sugarcane, timber,
  poultry, vegetables, maize, sheep, cattle, etc.)
• Willing to release confidential accounting
  
• and economic data

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Methodology (contd)

• Study Data
• Estimates of DPLG rebates
  
• Audited income statements and balance sheets
• Market value of land and fixed improvements (FI)
  (professional valuers)
• Farmers subjective estimate of the OC of
  management (expected salary in next best
  occupation x probability of securing that job)

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Methodology (contd)

• Empirical Analysis (RIM framework)
• Estimate real annual after-tax accounting
  profit/loss for 5 years for each farm (2006
  100), after charging real depreciation
• Estimate real annual economic profit/loss Real
  annual after-tax accounting profit/loss - real
  after-tax OC of management
• Does real economic profit (return to risk land)
  exceed land taxes ranging from 0.5 to 5 of the
  market value of land FI, with and without
  rebates?
  

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Results

• Case Study 1 Sugarcane Timber (816 ha)
  (Mtonjaneni)
• Market Value R7.5 million
  
• 70 rebate
• Real mean annual economic profit R161 821
• Mean annual return to risk land 2.16
• Land tax range R11 250 to R375 000
• Economic profit can pay a land tax of 1.5
• with or without rebates in 3 out of 5 years

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Results (contd)

• Case Study 2 Intensive Poultry Farm (170 ha)
  (uMngeni)
• Market Value R8.2 million
• 70 rebate
• Real mean annual economic profit -R401 724
• Mean annual return to risk land -4.88
• Land tax range R12 348 to R411 600
• Economic profit can pay a land tax of 1
• with or without rebates only in 1 out of 5
  years

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Results (contd)

• Case Study 3 Intensive Dairy Farm (434 ha)
  (uMngeni)
• Market Value R8.2 million
• 70 rebate
• Real mean annual economic profit R21 244
• Mean annual return to risk land 0.26
• Land tax range R12 267 to R408 900
• Economic profit can pay a land tax of 1
• with or without rebates only in 2 out of 5
  years

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Results (contd)

• Case Study 4 Leased Land (239 ha) (uMngeni)
• Market Value R1.96 million
• 65 rebate
• Real mean annual economic profit R59 797
• Mean annual return to risk land 3.05
• Economic profit can pay a land tax of 1
• with or without rebates in all 5 years
  (implicitly
• assumes that OC of management is covered!)

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Results (contd)

• Case Study 5 Mixed Enterprises (374 ha)
  (uMngeni)
• Market Value R3.6 million
• 70 rebate
• Real mean annual economic profit -R308 377
• Mean annual return to risk land -8.57
• Land tax range R5 396 to R179 850
• Economic profit cannot pay a land tax of 1
• with or without rebates in any of the 5 years
  

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Summary of Results

• The estimated mean annual rate of return to risk
  land during 2001-2006 for these five farms
  ranged from -8.57 to 3.05, with an average
  return of -1.60.
• The five case study farms ability to pay a land
  tax of 1 using annual economic profit ranged
  from zero to five out of five years, with an
  average of two out of five years.

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Conclusions Recommendations

• Case study 1 (Mtonjaneni Municipality ) on
  average could pay a land tax of 1.5 from current
  returns with or without rebates in 3 out of 5
  years during 2001-2006
• In Case studies 2 - 5 (uMngeni Municipality) on
  average, only one farm could pay a land tax of 1
  from current returns with or without rebates
  during 2001-2006.
• Results raise concerns about the ability of these
  farms to finance future investment in farm
  improvements (land tax will likely reduce the
  competitiveness of SA farms).

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Conclusions Recommendations

• Not a statistically representative sample of
  commercial farms in KZN ? Further research is
  thus needed in KZN and other SA provinces to
  estimate the impact of a land tax on the economic
  performance of farms.
• Will DPLG guidelines on rebates be implemented?
• Further research is also needed to assess if the
  estimated costs of a land tax (administration
  plus rebates) will exceed the expected benefits
  (revenue)

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• Thank you for your kind attention!