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China is edging toward a national property tax system. The Ministry of Finance expects to get approval for a pilot program in December to roll out in 2011 in cities such as Shanghai and Chongqing, according to Caixin Online.

There won’t be any decision until after the Central Economic Work Conference ends in December, Caixin reports, but since a property tax system would address some of China’s most pressing economic problems, the report certainly seems credible.

First, a property tax would take some of the hot air out of China’s very speculative real estate market. Right now, since property owners don’t pay any tax on their holdings, it makes sense to stockpile land or empty apartments in the hope of future price appreciation. Add in low interest costs—especially for the politically connected—and the costs of carrying a speculative real estate investment are extremely low.

Designing the tax system to control speculation without destroying market for owner-occupied housing isn’t simple. Some proposals that have been floated include taxes on market value rather than the original purchase price and graduated luxury tax rates that would rise with the floor space of a property. One goal of the tax would be to increase the supply of apartments on the market by giving the owners of empty “spec” apartments an incentive to sell.

Second, a property tax would give local governments a new source of revenue. Right now local governments are overly dependent on revenues from land auctions to developers. That has led to abusive land seizures with inadequate compensation to farmers forced off their land by local governments and to cozy financing deals that have put local governments into a deep hole because affiliated investment companies have made loans to developers for projects that will never earn a return big enough t cover the loans.

Chongqing and Shanghai have both already submitted tax proposals to Beijing, according to Caixin. The Shanghai plan seems to include a tax rate of 0.3% to 3%. In Chongqing the first taxes are likely to target luxury villas, and houses with appreciated values more than three times the average market price.

Investors can expect extreme volatility over the next few months in the shares of China’s big real estate developers such as China Vanke (CVKEF.PK on the Pink Sheet over the counter market), a big developer of residential properties in Shenzhen, Shanghai, and Beijing, as Chinese speculators place their bets on the latest rumors from Beijing. With shares of real estate developers making up a big part of the Shanghai and Hong Kong stock markets, you can expect that volatility to spill over into the general markets too.

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