Richard Murphy: Who Really Pays the Tax on Rents?

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Yves here. This simple point about tax needs to be made more often. Now you can make more complicated arguments, that a tax on rents might reduce the owner’s profit so much that he skimps on maintenance, but landlords who let their properties run down are destroying their asset’s value.

By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK

I was fascinated by this comment in The Guardian, published this morning:

Warnings by landlords that taxes on buy-to-let would cripple the property market, driving down supply and pushing up rents, have turned out to be entirely hollow, according to research by campaign group Generation Rent.

It found that since the “bombshell” introduction of taxes on buy-to-let landlords in George Osborne’s 2015 budget, rents have fallen in real terms.

Leave aside all issues regarding rents, inter-generational equality, and so on, and just think tax for a moment. What this comment makes clear is that if there is anything like a competitive environment (and in rents there is) then the incidence of taxes on rents is not on the consumer but on the owners of capital, as of course it should be.

I would suggest that the observation (not set up as an experiment, but by chance offering a large scale observation of actual behaviour as if an experiment was intended) is capable of extrapolation. Whenever suppliers are price takers (as in competitive markets they should be) taxes on suppliers will always be paid by suppliers and the suggestion that they are passed on to others makes no sense at all. This is now seen to be true for rents. I think it will be elsewhere.

So the next time you hear some rightwinger argue that tax is not paid by capital but is passed on to consumers or workers just note that what they are actually saying is that there are non-competitive markets in existence and that this fact should be their real focus of concern. But oddly, it never is. Right wingers are the last people who want competitive markets. They do not permit abuse, after all.

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  1. anon48

    “Whenever suppliers are price takers (as in competitive markets they should be) taxes on suppliers will always be paid by suppliers and the suggestion that they are passed on to others makes no sense at all.”
    I agree if the author’s point is being applied to income taxes only. In the US, other types of taxes such as property taxes, become an operating expense of the property, no different than insurance or maintenance. Whether the landlord or the tenant writes the check for the expense, economically, markets should adjust over time in a fashion as if the tenant pays. Triple net leases(tenant pays all expenses) are a common feature contained in many US commercial lease agreements. The same principle should apply to any rental operating expense that is perceived as reasonable priced and generally incurred consistently across a majority of properties in a particular market. Conversely, income tax rates for property owners can vary dramatically depending upon their own unique circumstances. So, it wouldn’t make sense that they could somehow be built in to rental agreements.

    “So the next time you hear some rightwinger argue that tax is not paid by capital but is passed on to consumers or workers just note that what they are actually saying is that there are non-competitive markets in existence and that this fact should be their real focus of concern.”

    My experience is that this is not an assumption that anyone makes (other than maybe some economists). All business clients I deal with, whether landlord or tenant, already know they’re the ones writing the income tax checks. Trust me, I hear about that every day.

    1. Yves Smith Post author

      People often rent properties at a loss because the losses would be higher than if they kept the space vacant. This was actually pervasive in Sydney when I lived there (2002-2004). Everyone who had bought an apartment as an investment property talked about it. I similarly rented a condo in NYC in the early 1990s for two years for below the owner’s costs, about $500 a month below. She only gave me a one year lease because she was hoping for a recovery, and had to renew at the same rental level because that was still where the market was.

      1. vlade

        In Oz I believe you can, additionally, subtract the loss from your income tax-wise (negative gearing). The idea being that the prices always go up, so you make money on selling the property. Don’t know whether Oz has or not CGT now, New Zealand didn’t use to, so it was very tax efficient there.

        1. Yves Smith Post author

          Oz has a VAT called a GST, is that what you mean? It was implemented just before I arrived.

          Yes, I am aware of the negative gearing, but the losses were significant that the expats who were long-term Sydney residents who bought property as an investment were still grousing about the losses. It’s still a cash drain because you deduct the loss from your income, not your tax liability. And even in 2002, Sydney property had had a very good run of appreciation.

      2. anon48

        OK…That may be a valid strategy overseas. But the passive active loss rules of IRC Section 469 (passed as part of the 1986 tax reform package) has prevented that from being a workable tax strategy over here for anyone over a certain income threshold.

        Agreed that other national or local conditions may have an impact that temporarily diverts the market in unforeseen ways (e.g. the real estate recession of the late eighties and early nineties was pretty severe)

        1. Yves Smith Post author

          You are ignoring Murphy’s case example.

          And landlords do not have a God-given right to profit on their investment. If something changes, like a new freeway makes their ‘hood less attractive because people want to live in new developments near the freeway, the landlord cannot sit there and say, “Well, I have my cost of capital and all these other costs” and demand a rent the market won’t bear. The landlord has to accept lower profit or a loss on his investment. He might dump it and the new owner might do fine with lower investment costs.

          Murphy’s point is a tax increase did not lead to rental increases. They won’t if the market won’t take it.

          1. anon48

            My point was increasing losses as tax strategy was not workable in the US( there can be some exceptions) because current US tax law would delay or prevent many landlords from enjoying any benefit arising from that strategy. And I understand that landlords are at the mercy of the market and already agreed with Murphy, for example, that personal income taxes should have no effect on what rents that could be charged.

            1. Yves Smith Post author

              You are still missing my point on Australia and Murphy’s UK example. This isn’t like the old US tax shelters where you could write off losses that were multiple times your investment and so have the tax losses be worth more than the investment. You can ONLY reduce your income by the amount of loss on a P&L basis. So you reduce your loss from $1000 to $600 after tax. It’s still a loss.

              And in the US, if the market won’t pay your cost of capital + your expenses, you have to accept not getting your target return. I don’t understand why you take the position implicitly that landlords will always be able to get a rent that allows them to get an acceptable return. You act as if it’s only at worst a short term blip when they don’t, when there are plenty of examples otherwise.

      3. CB

        that was clearly explained to me by one of the owners of a production printing company I worked for: I have, he said, fixed costs I can’t reduce, so whatever I make “buying work” offsets some of those costs. I lose less.

        well, when you put it that way……. something is better than nothing

  2. MisterMr

    My understanding is that this happens because landlords are price makers, not price takers.

    Take the example of a monopoly industry (the ultimate pricemaker): such industry has a fixed cost for each unit of stuff that it produces, and can apply any markup to this cost to obtain the final price (the markup becomes the industry’s profits).

    Even if the industry is a monopolist, the quantity of stuff that it sells depends on the price it sets, so that the total profit for the industry becomes:

    [quantity of stuff sold] * [unitary price – unitary cost]

    The industry will then see a slope in the sales such as the profits initially rise as the price rises, but then fall when the effect of the smaller quantity of sales surpasses that of the high unitary profits.

    Therefore there will be a “peak profit” price, and the monopolist industry will try to get that price.

    Now note that taxes influence the unitary cost un the above formula, so while taxes lower overall profits, they don’t influence the “peak profit” price, therefore for a monopolist all taxes are paid by business and not by customers.

    In other words, the more business has the upper hands in setting prices, the more taxes are paid by business and less by customers, as far as I can understand.

    1. Yves Smith Post author

      Uh, no. Rents vary greatly by city. Tell me why landlords can command rents of over $3000 for a one bedroom in Manhattan, even with a ton of supply having come on the market and rental rates being under pressure, while they go for less than half that in what has become a red hot real estate market, Portland, Maine. Incomes are way higher so landlords can charge more. A landlord that sets his price above market has a vacant unit. I suspect you’ve never tried leasing out an apartment. I have.

      1. lyman alpha blob

        Not arguing your main point but just wanted to point out that one factor that is driving prices higher in Maine is precisely people from NYC and Boston who can telecommute buying up property in the Portland area because it’s a lot cheaper than in their own areas. Most people in Maine don’t make enough to afford $1500 for a one bedroom.

        My wife spoke with a prominent real estate agent a couple years ago and he told her that in the last year he sold one property a week to people from Brooklyn alone.

        1. Yves Smith Post author

          Portland isn’t being driven by telecommuters from NYC or Boston. It’s Californication on the east coast. The city has gotten so nice it looks like a bargain, so a lot of people are buying second homes with an eye to retiring later or are retiring there, period.

      2. MisterMr

        Actually some years ago I leased out an apartment.

        I agree that landlords cannot lease at above the market value; the point is that the market value depends on the relative bargaining power of landlords and renters, so when the market value is high (like in Manhatten in your example) this means that landlords have more pricing power, hence they are (relatively) price makers.

        Or to put it in another way the market value is the “peak profit price”, as above that price actual profits fall because the landlord has longer time to wait to find a renter, or perhaps can’t find any.

  3. JW

    So this would apply to property taxes as well? That is, it would make sense for the local government to set high property taxes and then give relief to lower-income owner-occupiers?

    I think Vermont does this and its politically palatable because of all the vacation homes.

  4. Jenny

    Here’s a thought – now that its so easy to group chat, what’s stopping a bunch of landlords colluding against renters even if government tries to make the renting market more competitive?

  5. Jim A

    I remember during the RE bubble people claiming that because the price of houses was going up, the rents would obviously have to follow. I tried to point out that the rental market adjusts to supply and demand much more quickly because most rental property has a lease that has to be renewed every year. If there are too many empty units around, your landlord can’t raise prices too high or you’ll move out. OTOH, if there are very few rental units around, he can raise rents very quickly if there aren’t legal limitations on him doing so.
    This is in stark contrast to the RE purchase market, with it’s high transaction costs and and small proportions of sales to number of houses.

  6. michael hudson

    The basis of all classical value and price theory is that rents cannot be passed on. They are set “by the market” (often by monopoly power) in excess of the actual cost of production (defined to include normal profit).
    In practice, mot real estate is bought on credit. Buyers bid against each other to get the largest bank loan — and the winner is whoever pledges the most rental yield to the banker as interest.
    The lower the real estate tax, the more rent is available to pay the bankers. (“Rent is for paying interest” is the basic principle here.) So a property tax falls mainly on BANKERS, not the homeowner or renter.
    Only if the buyer uses 100% equity (not a frequent practice) does the landlord pay. In any case, taxes do not fall on the renter, because the landlord already is charging as much as the market will bear.

    1. Synoia

      So a property tax falls mainly on BANKERS

      The assertion is: interest + tax is constant in a market. Are there examples of this? One would expect interest payments to fall (through a drop in property prices) in a market if taxes are raised, and vice versa.

  7. Adam Eran

    …A timely reminder now that removing restrictions on rent control is on the California ballot for 2018, and the “split roll” measure closing the commercial property loophole in Proposition 13 just qualified for the 2020 ballot, too.

    1. Synoia

      One of the issues in California is that “densification” is nearly impossible in a residential neighborhood. We are stuck with suburbs, with little or no mechanisms to change from low density suburbs to high density cities.

  8. ewmayer

    “Whenever suppliers are price takers (as in competitive markets they should be) taxes on suppliers will always be paid by suppliers and the suggestion that they are passed on to others makes no sense at all. This is now seen to be true for rents. I think it will be elsewhere.” — By way of ‘elsewhere’, note that Wolf Richter has made a similar argument tariffs, namely that businesses which fattened their bottom lines via offshoring-based labor arbitrage failed to pass on most of the cost savings to their customers, and – again, as long as there is genuine competition – by the same token will not be able to pass on extra costs due to tariffs.

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