By Natalia V.Kalinina

(Center for Real Estate Analysis)

Historical background

The city of Novgorod called in the Middle Ages “Its Magesty Novgorod the Great” – is apparently the oldest city at the territory of Russian Federation located in North-West of it. It exists and functions for about 1130 years already. Being the first (and the longest) local democracy city-state it was extremely wealthy and powerful until it was joined to Russian State in 16^th century. Since than Novgorod’s role in Russian political and and economic life started to deteriorate. However, Novgorod’s place in Russian Empire times was not negligible. When 1000-years anniversary of Russia was celebrated, the memorial devoted to this event was established in Novgorod as unanimous recognition of its role in history of Russia. During the World War II it was completely destroyed and only 57 citizens were meeting Soviet Army when the city was liberated from Germans. However few churches were also ruined, the majority of them survived including St. Sophia Cathedral of 11^th century. Due to the powerful combination of historical and cultural values concentrated in Novgorod and innovative policy choices of local government, this city provides interesting example of urban development.

Soviet period heritage

Novgorod was completely restored and built again since 1940-ies – only 40 houses was left in the city after occupancy ended in 1944. Population increased tremendously between 1950-ies (around 30 000) and 1970-ies (more than 200 000). Migration from surrounding villages was main source of people.

Due to the regional policy choices which stipulated redistribution of economic wealth in favor of (a) capitals and large cities and (b) national republics and entities, by 1980ies Novgorod’ region (oblast) became one of the poorest regions, with decreasing population. Industries and jobs concentrated in the city of Novgorod with prevailing role of defense industries. The lack of natural resources (timber resources are available) and economic development disparities typical for socialist regional patterns made a good contribution in environmental status of the area: it is considered to be clean region, Valdai county is one of favorite resorts used by Soviet bureaucracy, till nowadays.

Background information

The modern city of Novgorod with 240 000 population is a capital of Novgorod region. Being unique in terms of cultural and historical values it is attractive for tourists. Novgorod represents standard pattern of urban settlement and it suffers many typical problems similar to those of other cities: under-maintained housing stock, deteriorated facilities, lack of funds for infrastructure development, economic decline, collapse of majority of enterprises representing state-supported industries. However, policies, which are implemented by the city government since 1993, supported by regional (oblast) government created basement for break through and some positive results started already to appear.

Stable political situation contributes to the positive results of reform oriented economic policy. Elected Mayor and City Duma (elected representative body) work in close cooperation developing local self-government mechanism. Governor for region who was also voted for by overwhelming majority of population supports local government strengthening and reestablishment of democracy at municipal level.

Reforming efforts

Privatization processes started in 1991 from housing – households were suggested to privatize municipal apartments free of charge. By 1997 more than half of housing units became private. Privatization of enterprises was also successful. In 1993-1994 following privatization of small and large businesses real properties were transferred from state and municipal into private ownership. Privatized enterprises were allowed to buy off land – as a result more than 10% of industrial land (around 20 parcels) belongs to private landlords, including largest industrial plot of about 600 hectares.

Substantial privatization of real assets together with the general collapse of (Russian) economy and emerging market infrastructure pushed the development of secondary market for real estate. Housing market was booming in 1992-1995, while market for commercial and industrial real estate is still very narrow. However, due to the tough land policy (rent rates are extraordinary high) and friendly regulatory environment secondary transactions with non-residential properties and land indicate shaping real estate market.

Regulatory reforms became a focus of local government policy since 1994. The main area for those activities were title registration, developing land market through auctioning vacant land for development, establishment of modern land-use mechanisms and urban planning practices, and innovative housing sector policies.

Title registration was implemented since 1994, when the Real Estate Department of city administration was given responsibility for registering property rights and their transfers for all parts of real estate including apartments, non-residential buildings and premises, and land. This created attraction for investors, as Novgorod was the first and for a long times one of very few cities having title registration unified. as the federal law “On Registration of Real Property Rights and Transactions” came into effect in 1998 only.

First land auctions and open bidding for infrastructure development took place in 1995 – 1996, as part of the World Bank Housing Project, also for the first time in Russia. In late 1997 special Presidential Decree disseminated this experience allowing selling land for development in urban areas.

Switch from socialist type land use regulation based on the parcel-based targeted use restrictions to the modern land-use concept was stipulated by the Zoning Regulations which were approved by the City Duma in 1997. Novgorod is so far the only city in Russia where the Zoning Code exists legitimately. This simplifies land-use practices for investment projects and is beneficial for investors, as eliminates a lot of bureaucratic procedures.

Housing reforms are implemented in the following areas: privatization of maintenance companies, promoting condominiums, harmonization of rent policy.

• Instead of mandatory link between few apartment blocks and so-called territorial maintenance company which enjoyed exclusive right to deliver services (typically low-quality and expensive), Novgorod citizens may now decide which company to hire. That leads to competition for clients and after all – to the better service.
• The way housing was privatized caused mixture of ownership. Practically each multi-family apartment block (dominating type of residential estate) represents a combination of private and municipally owned apartments. To stimulate participation of residents in maintenance and management decisions, the federal law “On Creation of Partnerships of Residential Owners” stipulates development of condominiums which are granted more rights and responsibilities rather than individual owners. Novgorod government helps to establish condominiums, trains personnel, and supports their activities – as a result more than 20 condominiums existed in Novgorod by the beginning of 1998 (the total number of condominiums in Russian Federation does not exceed 120 currently).
• According to federal laws and Government Resolutions, budget subsidies for housing , maintenance and communal services, which nowadays reach 35-40% of local budgets expenditures, should gradually be eliminated. Rent increase is unpopular and politically difficult action, so that very few cities are indeed implementing it to the full extent, Novgorod being one (if not the first) of them. In 1997 the city experienced big housing rent increase which is considered to be a success story and example for other cities.

1. Federal programs. Novgorod oblast participates in few federal programs which help to populate it, first of all – military officers resettlement program of Russian Government. Household which would like to leave North an North-East regions are also welcome to Novgorod oblast. Due to the friendly migration policies many talented people from other regions and former republics of Soviet Union were accommodated and employed in the region. Other focus for local government activities is implementation of “Housing” and “Own House” federal programs.
2. International programs. City of Novgorod actively participates in few international projects and programs including those of international financial organizations. The World Bank (IBRD) loans for housing, water and sewer system, transportation, enterprise housing divestiture and few others are being implemented in the city. European Bank for Reconstruction and Development (EBRD) also has projects with Novgorod region. Intensive technical assistance projects are in place or implemented already for land cadastre development (Sweden and TACIS), real estate information system, zoning, property tax reform, housing sector reforms and other areas. US Congress approved the “Partnership for Freedom” program aimed at comprehensive multi-dimensional assistance and cooperation to regions of Russia - first of all, for Novgorod region. Besides, Novgorod city has over 10 brother-cities abroad, and develops bilateral contacts with several regional and local governments and business communities.

3. Investments are given special fiscal and technical support. Investment projects are exempt from local taxes as well as are granted privileges with regard to federal taxes shares going to local and regional budgets – for the investment repay period. The technical support and administrative supervision is provided to investors during the preparation of the project, so that problems and bureaucratic delays are minimized. The property tax reform has started in order to harmonize tax burden distribution among sectors and activities. It is envisioned that implementation of real property tax instead of enterprise assets tax and land tax will take tax burden off the working capital (mashinery, equipment, inventory, materials etc) and promote modernization of industrial production and more efficient use of real estate.

4. Fiscal decentralization is designed and implemented by the regional government in order to create stable long-term intergovernmental arrangements. Typical for Russia situation is when regions are fighting to get more budgetary rights with the federal level but do not want to further decentralize to give more power to local governments. In Novgorod oblast not only expenditure functions were pushed down, to the municipal (cities and raions) level but also sources of revenues were reallocated. Oblast sacrificed some of tax shares to support financing of local services (hospitals etc.). For example, oblast share of enterprise assets tax is 40% (compare to typical 50%), land tax is shared between federal 30% and municipal – 70% - budgets (typically, it is 30:20:70 for federal, regional and local budgets correspondinly/

5. Managing political stability is given special attention by the local government. The final purpose for reforms is to improve life of citizens. Harmonization of social and political climate is achievable through democratization, openness to public, publicizing policy choices and using participation mechanisms. This occurs in Novgorod due to professional work of sociologists and through sociological pools, work with media, other procedures supporting regular feedback to electorate. The newspaper published by the city is delivered free of charge to every apartment being a regular liaison between government and population.

6. Information availability, marketing of the city and region became the focus of government’ efforts since 1997. The city has over 10 twin-cities in several countries of the world, including Rochester (USA), and etc. Most recently the government emphasized importance of professional efforts to do marketing of the region, attracting investors. For this purpose special materials are prepared by few entities including Novgorod State University, web-server pages for Novgorod were created for Internet.

These policies are aimed at promoting economic growth in order to re-establish Novgorod –the-Great as the most democratic and wealthy place in Russia.

Property tax reform

Property tax experiment is prepared in the city of Novgorod. The special federal law allowed local government (upon support from region) to replace existing land and assets taxes by the new, market value-based real property tax (this law is for two cities only – Novgorod and Tver which was also allowed to experiment).

The property tax is viewed as the instrument to promote fiscal decentralization, to provide local self-government with the stable source of financing infrastructure. It is expected that implementation of market value-based property tax will help to stabilize payments for land and make them predictable, equalize tax burden of various types of properties, promote efficient use of land and buildings and development of secondary market.

Receiving part of the market value of real estate, local government will become interested in market development and market value increase. The main obstacles for investment activities are instability and political risks and vague, confusing property rights. Even though it is possible for privatized enterprises to buy off land at rather low price, the land tax is changed by the federal government every year, so that there is no predictability of expenses for investors. The land rent also varies tremendously from year to year, and – because it is set administratively – it tends to squeeze profits from land-users as much as possible, every year. Due to market value-based property tax the local government will depend upon market behavior, and will support the market through transparent and stable rules and property rights guarantees. When implemented, property tax reform will promote investment activities and create (financial) ground for long-term planning and investment projects, including (but not limited to) public infrastructure development projects.

Property tax experiment is designed in the following way. The property tax rate is calculated based on targeted revenues to be collected and tax base estimate. The tax base consists of assessed values of all taxable properties in the jurisdiction. Assessed value equals to market value estimate multiplied by the assessment ratio which shows what portion of market value is taxable. Assessment ratios are defined based on analysis of tax burden shifts by groups of properties, industries, or taxpayers. Assessment ratios vary from 2.5% for residential properties to 100% for some types of commercial real estate.

Computer assisted mass appraisal techniques are used to estimate market value of properties – based on sample of market data models are developed and applied to all properties in the jurisdiction. In order to apply models and automate property records the fiscal cadastre was created. In Novgorod the fiscal cadastre includes technical and legal description of 111 000 properties. The property record is related to title / rights information as well as to taxpayer information.

Construction of the fiscal cadastre and valuation of all properties provided unique opportunity for the city managers to design policy based on precise and complete information. Novgorod is the first city which has this opportunity and it is expected that it will have the great impact on other cities.

The most difficult and painful issue of urban development nowadays is land allocation and land use policies. In socialist economy land considered to have no value, although in reality it did have value. Land allocation was done based on political considerations and power: biggest enterprises received as much as they would want, in the best areas. Residential areas happen to be pushed to outskirts of cities. At the same time, developers were (and still are) requested to bring the city in-kind contribution – to develop or restore engineering infrastructure, build roads or improve (add) public transportation lines. Urban development was supply-driven and poorly administered (often by corrupted bureaucracy). So far the land policy did not change much. Cities tend to control and influence (fight) market forces through old land allocation patterns, and ad hoc land payment policy. The land rent rates are often negotiated biggest companies being privileged. Switch to transparent and predictable land payments mechanism will tremendously benefit urban development patterns. Property tax experiment is expected to support new way of the urban land policy formulation.

The implementation of the real property tax must radically change the existing land use pattern and facilitate more efficient use of urban land. However, in view of the small area of land used under the property right, any change in the tax policy should be coordinated with the appropriate reform of land rent policy/ The modification if the land rent policy pursues the following aims:

• bring land payments as close as possible to land market assessment;
• avoid any sharp, revolutionary changes of land payments for land users;
• try not to trigger mass-scale buy-out of lands under privatised enterprises in order to prevent a possible reduction of future profits (a small difference between the tax rate and land rent rate for commercial lands);
• unify rent rates for commercial real property so as to create competition for prime lands including buy-outs and increasing efficiency of urban lands;
• stabilise rent rates by way of transition to the market value; make any change in the rent rates predictable in order to forecast land uses in future;
• envisage the prospects for bringing close the land payments for commercial and industrial users as a basis for more effective and efficient land use.

Real property tax rates and rent rates on land can be established and their changes envisaged based on the targeted budget revenue growth and facilitated investment in-flow.

Annex 1 gives you an example of the development of a real property tax policy (dynamic rates and assessment coefficients), land rent regulation and identification of land buy-out terms for non-privatised enterprises on the basis of the targeted growth of regular land payment revenues ( of the land constituent of the property tax and the rent) within ten years.

The transition to the taxation of real property based on the market value will help to project revenues under various options of the authorities’ policy and justify the choice of a land use, taxation and investment facilitation strategy.

In addition to the obvious positive outcome of a growing profitability of the real estate, the stable tax regime for property-related and land payments will improve the entrepreneurship climate and promote business activities in the cities. This will ensure growing income taxes on individuals and profit taxes on enterprises. Thus the fiscal impact of the implementation of the new real property tax will be much more than a mere increase in the tax revenue. Besides, the budget surplus from the new tax will be combined with broader social and economic changes, namely, more intensive and efficient use of urban lands, “transparent” budget and democratic regional management.

General budget revenues from taxes and land rents are considerably affected by the established land use patterns. The proceeds from land sales into private property and/or sales of long-term rent us another type of revenue which are different from the regular revenues described above (taxes and rentals).

The choice of the policy and land use procedures by the city is determined by several parameters:

• in the option of the targeted maximisation of short-term revenues and the fast development of the land market, the best policy will be to foster land buy-outs into private property and develop secondary land market in the city, this to be supported with liberal prices when lands can be sold free or for an insignificant fee;
• in the option of the targeted maximisation of land rent revenue the best policy will be to limit land privatization by using extremely high prices; to sell long-term rent rights only; to modify rents according to a changing market situation. This policy may be successful only if the city is highly attractive for investors and business people (like Moscow), provided the land use policy in the neighbouring areas is not competitive. If this is not so, the investors eventually will drift to other regions/cities, and the aggregate income from land rent and land development would fall considerably;
• in the option of the targeted maximisation of combined proceeds from land sales and rent in the long-term, the best policy may be to allow a coexistence of various land use mechanisms: private property and short-term/long-term leases. Both property rights and leasehold rights may be traded over. Selective policy to facilitate land sales, the use of economic tools (start-up prices, tenders, etc.) to manage the behaviour of the land users and regulation of owned lands /rented lands ratio should be provided.

The following real property tax rates have been used:

commercial - 3.0%

industrial - 1.5%

The sample included the land parcels under detached buildings which belong to industrial and commercial enterprises

Table 1
 
 

Diagram 1

Diagram 1 shows projected revenues from regular payments for land: land rents and land taxes for the period ending 2007. This dynamics will be true, if:

1. market value of urban land grows by 2.5 times on the average (graph 1);
2. a share of land owned by legal entities does not exceed 5-% of the total city land area used on the paid basis (graph 2);
3. commercial and industrial land rent rates become equal 4 years after - by 2001 (Table 1).

Graph 2

The regulation levers will be as follows:

1. the involvement of investors; and increasing demand as a result of stabilisation of payments and investments into the city infrastructure (with the resulting increase of market values);
2. the establishment of buy-out prices at the level which would secure profitability of land sakes into private ownership as compared to land rents for not less than 50 years;
3. the regulation of rent rates according to their social and economic acceptability.