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Suppose the government puts a tax on all apartment owners (e.g. a certain percentage of the apartment value), whether or not the apartment is rented. Will this tax cause an increase in rent?

From an economics point of view, it seems the answer should be no (at least in the short run): the tax has no effect on the supply or the demand so there is no reason that the rent should change. If landlords could take a higher rent, they would do so now. If they don't take a higher rent, it means that they cannot do so in the current market conditions, so they will not be able to raise the rent even when there is tax.

But from a psychological point of view, the answer may be yes. Why? Because landlords often don't raise the rent to the maximum possible level given the market conditions. Often, when a tenant rents an apartment for many years, the landlord prefers to keep the rent constant in order to keep good relations with the tenant. But, when there is tax, the landlords have an excuse to raise the rent. They can say "we are sorry, we would really like to keep the rent as it is, but we must raise it to cover the new tax".

Are these considerations correct?

What is more likely to happen in reality?

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A property tax:

In the short run, a property tax will have no effect on rent, as the supply of homes is fixed (i.e., supply is totally inelastic in the short run), and demand is relatively inelastic but not completely so, so the incidence will fall on property owners. In the long run, a property tax will increase rental costs because supply of new units (i.e., construction) is highly elastic and long-run demand for housing looks just like short-run demand— relatively inelastic. As a result, the incidence of the tax will fall on occupants (both renters and owner-occupiers).

Intuitively, one could think of it this way: the cost of ownership will increase due to the tax, so for someone to see it as worthwhile to buy a newly-constructed home to rent out, the rental income would have to be relatively higher in the presence of a property tax than if one were not in place.

A tax on rental income:

The tax will increase rent; it will decrease the supply (and demand) of rental units (and increase the supply and demand of owner-occupied units). This will happen because the tax will reduce the return on apartments as revenue assets, causing some number of landlords to sell them to owner-occupiers, taking them out of the rental market. More importantly, though, there will be some renters who do not have the option of switching to owner-occupancy, and they'll bear the incidence of a tax on rental income.

I am assuming that there are three populations:

  • Landlords, who can choose to purchase homes for rent, but live elsewhere, so their choice to buy a unit to rent out can be analyzed separately from their own housing consumption
  • Renters, who must rent, due to some frictions (inability to afford a down payment, poor credit, unstable or difficult-to-document income history, etc.)
  • Potential owner-occupiers, who can choose between owning their own home and renting from a landlord, and who have some set of preferences between ownership and rental

Thus potential owner-occupiers and landlords compete for units for sale, while renters and potential owner-occupiers compete for rental units.

In this case, the choice of landlords to exit due to taxes will not pass through perfectly to the rental market due to the fact that while potential owner-occupiers who are currently renting can escape the tax by switching to ownership, there are some renters who are renting whose demand for renting is pretty inelastic— these people will bear the incidence of the tax.

Interestingly, in the US there is such a tax on rental income, though it's implicit. We have a bunch of incentives for home ownership, notably the exemption from capital gains for owner-occupied homes, but most importantly the fact that income on rental properties is taxed like any other business income, while owner-occupiers effectively rent their homes to themselves without paying tax on the implied rental income. (As an aside, people often point to the income tax deduction for mortgage interest payments, but this actually just creates tax equivalence between homeowners and landlords, who can deduct interest as a business expense.)

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  • $\begingroup$ But if landlords sell their assets to owner-occupiers, the demand for houses for rent is also reduced! $\endgroup$ – Erel Segal-Halevi Sep 16 '15 at 5:17
  • $\begingroup$ @ErelSegal-Halevi: Ah, I see what you're asking. Please see edits! $\endgroup$ – dismalscience Sep 16 '15 at 16:52
  • $\begingroup$ Regarding the short-term analysis: is there any room for the psychological consideration that I mentioned? I.e, is it possible that, despite the fact that the incidence should fall on the property owners, they will use the tax as an excuse to raise the rents? $\endgroup$ – Erel Segal-Halevi Sep 24 '15 at 14:19
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    $\begingroup$ Of course— it's impossible to rule such effects out with theory alone. $\endgroup$ – dismalscience Sep 29 '15 at 22:57
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Ultimately it is the individual who pays taxes. I believe this is why the framers of the US Constitution vested the House of Representatives with the power to levy taxes.

From where do landlords obtain the money to pay the taxes? They obtain the money from the renters. So it is the renters that pay the taxes levied by government on landlords.

EDIT:For some reason I am unable to add the following as a comment on the comment given below, so I am putting it here.

In an economy, with sufficient competition, the profit margin of the landlord is driven down to a reasonable level. Without profit the owner of the house is not motivated to rent out his property. It is not 'evil' for the house owner to receive profit. In my investment portfolio I own a REIT. From that REIT I receive a quarterly profit. Yet I, myself, am a renter of the house in which I live. As a renter I get to call on my landlord anytime that I have a problem with the house. For that privilege my landlord makes a modest profit. If I accept the profit from the REIT which I own yet deny my landlord his profit from the house in which I live then I am a two-faced cheat.

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  • $\begingroup$ "They obtain the money from the renters" - this is not necessarily so... it is possible that the taxes just reduce the homeowners' profits. This is exactly the question... $\endgroup$ – Erel Segal-Halevi Sep 24 '15 at 14:19

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