Expanded budget deficits and continuous borrowing by successive governments pushed the Sri Lankan economy into a recession. These heavy borrowings placed a significant burden on the shoulders of today’s citizens. The previous government was compelled to seek assistance from the IMF to revive the economy, which led to increased tax rates, a broader tax base, and the introduction of new taxes. The present NPP government has introduced some tax revisions. However, it too must increase revenue in order to address the economic crisis and promote sustainable growth. This is why the country is going to introduce property tax in 2027. In other words, the government’s tax demand increases in the near future. This note is to provide a brief introduction on property tax that we will have to pay.

Property tax

Governments may impose various types of taxes, though some countries choose not to levy certain kinds. Property tax is no exception. After considering the taxation of income and expenditure, many countries also tax stocks of wealth. Such taxes may be imposed on individual pieces of property—payable by the owner and classified as impersonal in rem taxes (those imposed on objects or activities)—or on the total property holdings or net worth of a person, making them personal taxes.

When we hear the word property, the related concept of wealth also comes to mind. However, there is a distinction between property tax and wealth tax. Property tax generally applies to real property, while wealth tax is levied on total net wealth (all assets minus liabilities). Some countries, such as Spain, Switzerland, Norway, and France, impose both taxes simultaneously. Property tax, however, is widespread globally, though it remains relatively novel in Sri Lanka. Property tax is generally divided into two categories: real property taxes and personal property taxes, both of which are often referred to as ad valorem taxes (taxes based on the value of property).

Real property (realty) is defined as land and whatever is erected or growing on the land or permanently affixed to it. It also includes subsurface features such as mineral deposits. Real property taxes are levied on the ownership of land and buildings, with the tax base being the property’s monetary value. Because real estate cannot be moved or hidden, and its ownership is a matter of public record, it provides governments with a highly reliable tax base. These taxes are typically assessed annually, based on market value as determined by local authorities. Elected or appointed officials are responsible for valuing the property and notifying owners of the assessed amount. A distinctive feature of real property taxes is that the tax rate is set each year according to the jurisdiction’s revenue needs for that budget cycle.

Personal property, in contrast, refers to any asset that is not real property. Like real estate, personal property is taxed based on its value, but unlike real property, its value is usually not assessed by government officials. Instead, individuals and businesses must determine the value of their taxable assets and report it to the tax assessor. Taxable personal property generally falls into three categories: household tangibles, business tangibles, and intangibles. Household tangibles commonly taxed include automobiles, recreational vehicles, pleasure boats, and private aircraft. Business tangibles include inventory, furniture, fixtures, machinery, and equipment. Intangible assets most often subject to tax are marketable securities such as stocks and bonds.

Determination of tax rate

An individual’s property tax liability is calculated as the product of the tax rate and the property’s assessed value—the value assigned by the local authority. In most cases, jurisdictions (local authorities) attempt to align assessed values with market values. However, if a property has not been sold recently, its market value may be unknown, requiring the tax authority to estimate based on the market values of comparable properties. The degree of divergence between market and assessed values depends on the accuracy of the estimating process.

Empirical evidence shows that many jurisdictions perform poorly in assessing property values, leading to situations where properties subject to the same statutory tax rate face vastly different effective tax rates. In the United States, for example, thousands of jurisdictions operate their property tax systems independently. None include a comprehensive measure of wealth in their tax base, and there are significant differences in what types of property are excluded and what tax rates are applied.

Some communities grant preferential treatment to new business facilities to encourage investment, while few tax personal wealth beyond homes. Assets such as cars, jewelry, and financial securities are usually exempt. Generally, structures and the land on which they are built form the core of the property tax base, though effective rates vary widely across jurisdictions.

For businesses, calculating property taxes can appear complex, but with the right tools and a sound understanding of the fundamentals, the process becomes more manageable. The cornerstone is determining the assessed value, typically carried out by a government assessor who evaluates factors such as land, buildings, and improvements. Equally important is establishing the tax rate, commonly referred to as the mill rate. The mill rate represents the amount of tax owed per Rs.1,000 of assessed property value and is determined annually by local authorities in line with revenue requirements.

Reasons to pay

There are several theoretical bases for imposing taxes. One rationale for wealth taxation is the benefit principle: public services, such as road modernisation, increase the value of real property and should therefore be financed by property owners. This argument can be traced back to seventeenth-century natural-law theorists, who viewed one of the state’s primary functions as the protection of property. From this perspective, property owners are obliged to contribute toward the state’s expenses. Logically, such reasoning supports a comprehensive tax base that includes all forms of property—both tangible and intangible.

Property tax can also be understood as a user fee, since communities rely on it to finance essential public services such as education, healthcare, and policing. In this sense, the tax is not merely a levy but the cost of accessing and maintaining vital services that benefit society as a whole. Beyond theory, Sri Lanka faces practical imperatives for broadening its tax base and strengthening its fiscal framework. Expanding property taxation could play a critical role in addressing the country’s debt crisis while fostering long-term economic growth and development.

Impact, incidence and effects of the tax

The impact of a tax refers to its first point of contact with taxpayers—that is, the person who initially pays it. In the case of property tax, the legal liability usually falls on the property owner. Local governments assess the value of land and improvements, and the owner must pay tax based on this assessment. Thus, the immediate burden is borne by the property holder, whether an individual, household, or business. Because property taxes influence both investment and location decisions, most European countries allow businesses to deduct them: of the 27 that levy property taxes, 23 permit deductions from corporate income, thereby reducing the effective burden and encouraging investment.

The incidence of a tax, however, concerns who ultimately bears the economic burden after adjustments in behavior, prices, and markets. Although property owners are legally responsible, the real incidence may shift. Landlords may raise rents to pass part of the burden to tenants, while businesses may shift costs forward to consumers through higher prices or backward to workers through lower wages.

The question of who ultimately bears the burden of the property tax has long been debated. Three main perspectives can be identified: the traditional view, the capital tax view, and the excise-on-capital view. Under the first, property tax is seen as an excise tax on land and structures.

Since the supply of land is fixed, landowners cannot escape the tax and thus bear the full burden. In many cases, the tax becomes capitalized into land values: prospective buyers discount the purchase price to account for future tax liabilities. As a result, landowners effectively bear the tax indefinitely. Capital tax view holds that if property tax is treated as a uniform tax on all capital, then the entire burden falls on capital owners.

Since capital income is concentrated among higher-income households, property tax in this view is progressive, contradicting the traditional view. According to final view property tax rates, in practice, vary by jurisdiction and property type, meaning it functions as a set of excise taxes on capital. Capital tends to migrate from high-tax to low-tax areas until after-tax returns equalize. This reallocation affects returns to other factors of production depending on their mobility. Land, being immobile, cannot escape the tax, while less mobile forms of capital are more likely to bear the burden. Over the long run, even the overall supply of capital may respond to property tax rates.

Property taxes have a range of economic and social effects. Firstly property taxes provide a stable and predictable source of income for local governments, often funding essential services such as education, infrastructure, and public safety. Secondly, when designed well, property taxes can contribute to equity by taxing wealth more directly than income or consumption taxes. However, poorly assessed property taxes can be regressive, disproportionately affecting those with lower incomes relative to property value. Thirdly, property taxes on land are often considered efficient since land is immobile and cannot be hidden, making it a strong tax base.

Taxes on improvements (buildings) can, however, discourage investment in property development or maintenance. Fourthly, high property taxes may influence housing decisions, business location choices, or patterns of land use. Preferential rates or exemptions can also create distortions, such as attracting businesses or encouraging certain types of development. Fifthly, because property taxes are highly visible and often unpopular, they can provoke resistance from taxpayers, influencing local politics and policymaking.

Sixthly, as a tax on real estate, property taxation can distort economic choices. It may encourage substitution away from real property toward other inputs, or toward consumer durables in states where personal property is taxed less heavily. This can discourage housing production and consumption. Finally, property taxes may also affect location decisions. Since rates vary across communities, industries that rely heavily on real estate tend to locate in lower-tax areas. At the same time, businesses also weigh the public services financed by local property taxes when deciding where to operate.

Empirical evidence further illustrates these dynamics. In 2011, China introduced property taxes in Shanghai and Chongqing, targeting second homes and high-end properties. A 2021 study found little effect on housing prices, mainly due to the narrow tax base, low rate, and generous exemptions. By contrast, a German study (March 2021) found that higher property taxes were fully passed on to rental prices within three years, though the pass-through was weaker when housing supply was inelastic. More broadly, property taxes tend to be capitalized into purchase prices, lowering what buyers are willing to pay, while in rental markets, part of the burden may also be shifted to tenants.

Decisions to be made

Sri Lanka is expected to introduce a property tax in 2027. However, several key decisions must be made before implementation. First, which level of government will be responsible for imposing the tax? In many countries, property tax is administered by local authorities. In Sri Lanka, it must be decided which layer of government will have the authority to levy and collect the tax.

Second, the scope and rate of taxation must be determined. Property can take many forms, but for real property, land and buildings are the main categories. If buildings are included, should the tax apply to all types—including residential houses? Since houses vary greatly in size, facilities, and value, questions arise as to whether very small houses should be taxed. In some countries, only second or additional properties are taxed. With respect to land, it must be decided whether all types of land will be taxed. For example, paddy land presents a special case, as profit margins in paddy farming are often extremely low, or even negative. This calls for certain exemptions, deductions, or abatements. Common exemptions internationally include those for non-profit organizations, historical properties, or primary residences (homesteads).

Third, the treatment of depreciation and improvements must be clarified. Property assessors typically evaluate factors such as age, condition, and maintenance in determining depreciation, as well as any improvements or renovations that increase value. Since different assessors may apply varying standards, this can result in inconsistencies in assessed values.

Why is the property tax so unpopular?

Several explanations have been offered. Because housing transactions occur infrequently, property tax assessments are based on estimated values. If these valuations are inaccurate or biased, the tax is seen as unfair. The tax is also highly visible: unlike income and payroll taxes, which are withheld from wages and remitted by employers, property taxes are typically paid directly by homeowners, often in large quarterly or annual installments. These lump-sum payments can feel like a financial shock. Some property owners, particularly the elderly, do not have enough cash to make property tax payments and may therefore be forced to sell their homes. A high property tax rate also affects property values. Other things equal, a heavily taxed property will sell for less. This means that while current owners may feel burdened, new buyers are not necessarily worse off once the lower purchase price is taken into account.

One ambitious reform would be to replace the property tax with a personal net worth tax. This tax would be levied on the difference between the market value of all a taxpayer’s assets and liabilities. Unlike the property tax, such a system reflects a truer measure of ability to pay, since debts can be deducted. It would also allow for exemptions and progressive rates. However, because people often hold assets and debts across multiple jurisdictions, a net worth tax would need to be administered at the federal level.

Conclusion

Alongside the need to address technical and political barriers to reform, the construction of more effective property tax systems also depends on improving levels of tax compliance. A key foundation of compliance is the presence of credible and fair enforcement: few taxpayers will willingly comply if they believe there are no consequences for evasion or if they suspect their neighbours are not paying their fair share.

It is well known that taxes are unpopular. However, Sri Lanka needs to broaden its revenue base and is preparing to introduce a new tax in the near future. In the past, widespread corruption undermined public trust, and many citizens paid taxes reluctantly, while some were able to evade them altogether. Today, with corruption more effectively controlled and public confidence in government improving, the conditions are more favourable for introducing a property tax. Still, such a measure must be implemented carefully to maintain public support and fairness.

Importantly, property taxes are widely considered the least harmful form of taxation, as they have the smallest negative impact on household and business economic decisions compared to most alternatives. For example, in 2010 the OECD ranked tax instruments by efficiency, from most to least: property taxes, value-added tax (VAT), personal income tax, and corporate income tax.

by Dr. Tikiri Nimal Herath✍️
Emeritus Professor
tikiriherath@gmail.com