Friday, 12 March 2010

Incidence and elasticities

Last night's news brought a story of the horrors to be visited on renters when and if the government moves to limit landlords' depreciation expenses. Lots of interviews with unhappy renters, lots of shots of the Labour Party's Trevor Mallard and his back of the envelope calculations of the effects on poor people.

The study was funded by the Property Investors' Federation.

I didn't see any counterpoint interviews with any economists asking if they'd seen the study or whether it made any kind of sense at all (I can't find the study online). Just shots of unhappy renters asked just how unhappy they'd be if their rents went up by the amount their landlords' lobby group claims rents will go up with the regulatory change.

Let's recall that the incidence of any tax will depend not on who the statute says has to pay it but rather on relative elasticity of demand and supply. The supply of rental houses is relatively inelastic: new houses are built only slowly due to resource consent issues, though that constraint is of course less binding in recession. But adjusting supply downwards is more difficult: properties can be shifted from rental to owner-occupied, but they're rarely bulldozed. They can be provided with less maintenance and allowed to erode over time, but that's slower. The demand for rental houses isn't all that elastic, but I'd be very surprised if it were less elastic than supply: renters can double up and rent with friends if prices increase. When the supply curve is more inelastic than the demand curve, the incidence of the tax falls mainly on supply.

The likely scenario:

After depreciation treatment is tightened up, landlords try to hike rents to keep their rates of return on even keel. Some tenants exit the rental market with the price hike (they're relatively more elastic). Some property owners can't find tenants and either eat the loss, lowering rents, or sell off the property. The rental property won't sell for a price that would earn the new property investor losses if he can only earn through rental income plus capital gain rather than rental income plus capital gain plus depreciation expenses that are never counted against capital gain. So the property sells for less, the new landlord charges a lower rent but one that covers his bills, and other properties follow suit over time.

So, Public Address seems likely right. Unless I'm very wrong about relative elasticities, the bulk of the burden cannot be passed on to tenants.

And it's mildly amusing to watch a po-faced Trevor Mallard talk about the horrible harms that will befall renters when he's the unwitting tool of the rentiers.

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