Why Rent Controls Would be Detrimental to Montgomery County.

Special interest groups in Montgomery County (MC) have been lobbying county government to enact rent controls.  It is always tempting for politicians to enact subsidies for voting constituents, especially when they outnumber those paying for them (landlords). Fortunately, County Executive Isaiah Leggett and most councilmembers recognize 1) the great harm that rent controls would inflict on the county, 2) the social benefits from letting competitive market forces determine rents, and 3) that there are better ways to target rent relief to those that are truly needy in MC.

Rent is the price paid for the use of a dwelling (a type of asset) owned by someone else.  As in other markets where the price is determined by competitive forces, the equilibrium rent is that amount that balances the value of a dwelling unit to the renter and the cost of building and operating such units by the owners.  Rent controls, a legal limit or ceiling on the maximum rent a landlord may charge a user of his property over a period of time, distort this balance, and, like other forms of price controls — agricultural subsidies, for example —inflict great harm not only on the affected market (the MC housing market), but the general economy (the people of MC).  A binding rent control ceiling would reduce both the quantity and quality of rental housing. With rents below market clearing levels, and thus below  the cost of owning a home and other forms of shelter, and with reduced rents in MC compared to neighboring counties, the demand for rental units in MC would increase above the equilibrium quantity supplied resulting in apartment shortages.  Over time, below market rents, which represent the return of capital invested in rental housing, encourages conversions to condominiums and uncontrolled luxury apartments, and reduces the incentive to invest in the construction of new apartment buildings. This gap between supply and demand widens and the apartment shortage worsens.  There is consensus among economists over these effects and the evidence is overwhelming. Even the Washington Post reported (May 7, 2010, “Low Rents in D.C. Vanish as Downscale Goes Upscale”) that in Washington, D.C., which has had rent controls since 1975, the supply of rental apartments between 2000 and 2010 declined by 50%.  This harms the very people that rent controls are intended to help.

Rent controls also worsen the quality of the existing stock of rental units. With rents below market levels —sometimes 50% or more below market rents —and with the rate the return on their investments less than the required rate of, and below the competitive cost of capital, less revenue is generated for maintenance and upgrades. But with renters also benefitting from the below-market rent, (which is a significant subsidy) they would be less inclined to move out of a low-rent apartment, which would encourage overstaying and reduce mobility.  Both of these effects would tend to reduce the quality of the existing stock of apartments. In New York City, for example, which has had rent controls since 1969 (in their present form), the tenants in rent-controlled apartments have lifetime tenure with rights of succession, which means that the landlords cannot generally even reclaim the apartment for their own use, thus losing their own property rights. Over time this quality problem worsens, potentially creating urban blight in some areas, particularly in the older areas of the county. 

The shortage created by rent controls intensifies consumer demand and makes the available stock of rental units more valuable.  This would engender a variety of non-price means by property managers, landlords, and renters (those lucky enough to find a rent-controlled apartment) to deal with the shortage, which would further distort the housing market. For example, as vacancies decline and the waiting lists get longer, property managers could impose arbitrary and discriminatory restrictions on the type of renters and their behaviors.  Also because space is scarce, and more valuable, those renters lucky enough to get a rent-controlled place have the incentive to sublet at the even higher willingness-to-pay (which is driven up by the shortage). In such cases rents would not really be lower; the original renter, in effect, earns the rent that would otherwise go to the landlord.  It is also likely, that side payments could be made by those whose willingness to pay (because they value the apartment more) is greater than the controlled price, thus encouraging a type of black-market in apartments.  Rent controls would also distort the balance between the price of rented and owned dwelling units, between the housing markets in MC and those in neighboring uncontrolled regions, and between types of apartments (e.g., luxury and non-luxury units).  While the authorities could find ways of addressing these distortions, it would not be able to do so without additional, and more complex, government regulation of the housing market, which would require a larger bureaucracy and increased spending, and cause an even more distorted and dysfunctional housing market.  

Finally, rent controls fail to address the real underlying causes of high rents in MC:  1) on the supply side, the cost of building and operating rental housing is high due to high labor and regulatory costs, and high taxes, particularly income, property, and energy taxes; and 2) on the demand side, population growth and high incomes.

Despite the general harm caused by rent controls, proponents justifiably claim that high rents are particularly burdensome for the poor elderly and disabled, many of whom 1) are on fixed incomes, 2) spend a disproportionate share of that income on housing, and 3) would find it difficult to move in response to excessive rent increases.  But, general rent controls are too blunt an instrument — and a poorly targeted instrument at that—to deal with this legitimate problem. General rent controls would subsidize all renters, rich and poor alike, when in fact not all renters are poor, elderly, or infirm, and not all landlords are young, rich, and healthy.  In New York City, one finds wealthy people among those living in rent controlled apartments (former Mayor Ed Koch, and Woody Allen, among others).

Governor O'Malley's $600 Million Double, Piggy-Back Gas Tax Plan

On January 30^th Maryland Governor O’Malley proposed higher taxes on incomes, water use, internet sales and broadband use, electricity, and motor fuels to fund a 3% spending increase and to cover a projected $1 billion budget deficit. One of these taxes, which would help fund his transportation programs, would be a new 6% sales tax on gasoline, diesel, and other motor fuels. The tax would be added to the existing State excise tax of $0.235/gallon of gasoline ($0.2425/gallon of diesel). If the Governor’s 6% sales tax is enacted, and when fully phased in after 3 years, Maryland would have some of the highest fuel taxes in the country.  Including the $0.184/gallon federal excise tax, gasoline sold in Maryland would be taxed at about $0.63/gallon, assuming gasoline prices of $3.50/gallon), and, as a consequence, Marylanders would face some of the highest fuel prices in the United States (the price of gasoline would exceed $4/gallon).  Diesel fuel, which is taxed more heavily at both the State and federal levels and which averages $4/gallon nationwide, would have experience even sharper price increases. 

               The Governor’s gasoline tax proposal would not only result in a second tier of taxes — a double taxation of motor fuels at the state level (the 6% “ad-valorem” tax and the $0.235/gallon “unit” tax). It would result in the compounding of Maryland fuels taxes — a sales tax being imposed on its own preexisting $0.235/gallon excise tax. Moreover, because of the way the federal government taxes motor fuels, the Governor’s proposal would also result in a “piggy-backing” of the federal gasoline tax — a tax on top of preexisting $0.184/gallon federal excise tax. The piggy-backing of the 6% sales tax on the existing federal gas tax means that, should the Congress raise the gas tax to finance its surface transportation bills, as it is likely to do in the future, the Maryland gas tax burden per gallon would also rise, even without any action on the part the Maryland legislature.

               To understand these compounding effects it is necessary to describe how gasoline taxes are imposed and collected at the federal and state levels. Generally, the federal gas tax is imposed on refiners as the gasoline “breaks bulk,” which essentially means when it is purchased by wholesalers and loaded onto trucks for distribution to retailers. To illustrate, say the average cost of refining gasoline, including a profit markup, results in a refinery selling price of $3.266/gallon. At this point, the refiner adds the $0.184/gallon federal excise tax and a wholesale-distributor that buys gasoline would pay the refiner $3.45/gallon (the “rack” price). Now consider Maryland’s fuel taxes under current and proposed law. Under current law, the wholesaler adds the State excise tax ($0.235/gallon) and a mark-up (say, $0.05/gallon to cover costs and a profit) to its purchase price and sells the gasoline to the retailer for $3.735/gallon. Under the Governor’s proposal, the wholesaler would also have to assess a 6% sales tax ($0.2241) on the already taxed product. Thus, retailers would pay $3.959/gallon to the wholesale (the $3.45 refinery price + the $0.235 Maryland per-gallon tax + the $0.2241 from the 6% sales tax + a $0.05 mark-up) and add in their own cost/profit markup to set the retail price to consumers. Assuming, again, that a cost/profit mark up of $0.5/gallon, the final selling price of gasoline to Maryland consumers would be $4.01/gallon. Note that the 6% sales tax would be imposed on the wholesaler’s $3.735/gallon selling price ($3.45 + $0.235 + $0.5), which includes both the $0.184/gallon federal tax ($3.45 = $3.266 + $0.184) and the current $0.235/gallon State tax. This would result in a total compounded gasoline tax of 2.51₵/gallon out of a total sales tax of $0.2241/gallon (6% times $0.184= $0.011/gallon, from the taxation of the federal tax, plus 6% times $0.235= $0.0141/gallon, from the taxation of the State tax).    

               As this example clearly shows, because all excise taxes on passed through onto the price of gasoline (a standard economic assumption with regard to excise and sales taxes) — they are embedded into the market price of gasoline — any ad-valorem tax will inevitably result in the taxation of each of the individual components of the gasoline price.  How much will the compounded taxes cost the typical Maryland motorist?  Based on recent gasoline and diesel consumption and prices, the total $600 million sales tax burden on motor fuels amounts to about $190/year for the average motorist), not a large sum, but also not insignificant at a time when fuel prices are already increasing due to higher crude prices.  Of this $190 per-capita tax burden, the effect of the compound tax alone is estimated at about $21/year, still a relatively small sum. In the aggregate, however, nearly $80 million (13%) of the $600 million in total revenues estimated to be collected from the proposed 6% sales tax (which would be higher as fuel prices increase) would result from compounding the two taxes. Regardless of its magnitude, however, as a matter of tax principle government should not be piggy-backing its taxes in an effort to finance its programs no matter how worthwhile those programs might be.