Tuesday, December 19, 2017

Closed Access and Public Sentiment - Taxes

I have been meaning to do a broader post on corporate taxes, incomes, etc., regarding the way that corporate taxes are being treated as if they are simply pocketed by shareholders.  This clearly cannot be the case in the long run in an open economy.  But today, I just want to make one brief observation.

I am wrong about that in a Closed Access economy.  And, this is one of many reasons why Closed Access is so damaging.

Here is a tweet from Kim-Mai Cutler, who does some great work on housing issues in California:
My first instinct is to naysay this tweet.  But, that's because my instinct is an Open Access instinct.  For classical economic models to work, we have to live in a sufficiently open system.  In Phoenix, making real estate passthroughs more profitable would be an affordable housing policy, because it would induce new investment into rental properties, it would make the pre-tax return required by real estate investments lower, and it would lower the rent on properties of a given cost.

We can argue how many subsidies vs. taxes we should apply to real estate.  Maybe we don't want to subsidize real estate.  That would be fine.  But, we should be able to agree that, in terms of rent - which is the important factor for actual housing affordability - subsidies to real estate investors will make the existing housing stock more affordable and will increase supply.

But, this doesn't happen in Closed Access cities.  There is a political limit to supply in those cities.  So, if tax policy shifts to give landlords more profit, they do pocket the profit.  It doesn't matter if new capital would be drawn to real estate in a Closed Access city.  Supply does not reflect economic costs and benefits.

To the extent that this benefits landlords while pulling back on mortgage interest deductions reduces benefits to homeowners, this set of policies probably does level the playing field a little more compared to how it has been in Closed Access cities, so that owner-occupiers with access to credit may be less likely to outbid landlords on existing units.

In general, Closed Access markets aren't governed by supply and demand, though.  They are governed by the battle over economic rents that are the result of political exclusion.  So, on new units, if the basic building cost would be $200,000 per unit, and they sell for $600,000 per unit, the difference will inevitably be claimed by various interest groups.  Mostly, the difference will be claimed through various impositions, fees, and taxes, that are negotiated between local governments and the builders.

So, policies like tax subsidies don't affect supply.  Instead, they affect prices - how far prices are above the natural market cost that would arise in a market that allowed new supply.  And, to a certain extent, they reflect a battle between various levels of government about who gets to claim the economic rents from exclusion.

Now, workers who might earn $100,000 in Atlanta may move to San Francisco where they earn $150,000, but with $40,000 in additional costs.  $20,000 of that might go to the landlord, $10,000 to the local government in taxes, and $10,000 to the federal government in taxes.

The proposed policy of eliminating the deductibility of local taxes might shift the economic rents, in the long run, all else equal, with $18,000 going to the landlord, $9,000 going to local government, and $13,000 going to the federal government.  (These are broad, made up numbers to help think about the context.)  So, reducing the SALT deduction is really a way for the federal government to get its hand on some of those economic rents.

It's tempting to say, let's find ways to tax those cities even more, until all the economic rents flow to Washington and there is no more advantage to political exclusion.  But, the best solution would be to open those cities up so that more Americans can benefit from the amenities and characteristics that allow those cities to collect economic rents to begin with.

On the other hand, our chosen policies have been so poor that bringing down home prices through targeted taxes on Closed Access cities would be a huge improvement on the policies we chose to implement in our zeal to bring down home prices.

In any case, the core of the problem is Closed Access.  Where the idea that capitalists just pocket public largesse might normally be fallacious, Closed Access makes it true.  And, this reasonably leads to a plurality in public opinion to enforce policies that are explicitly damaging.


  1. I'll say it again: Kevin Erdmann is playing in a higher league than other macroeconomic bloggers (certainly as pertains to real estate).

    This is a very insightful post, IMHO.

    Worse, there are large but entirely unexplored ramifications of property-zoned limited access regions for monetary and trade policy.

    Let's close our eyes and shoot!

  2. I think about this,in cities were too little building is allowed some part of any subsidy of the lowest 30% of earners will be captured by landlords? SNAP, TANF, EITC etc.

    1. Yes. I think you are basically right. At the margin, the city is designed to force them out, and so any extra income will have to filter through their cash flows to be applied to the bidding war on housing.

      Here, I think it is the incongruity created by subsidized housing that leads to polarization. For individuals in subsidized housing, they probably do keep most of those other subsidies, and the bidding war is squeezed into the housing stock that rents at market rates. So, for those who prefer state-based solutions, it appears as if the combination of below market rate units and public income subsidies is an effective way to get resources into the hands of less fortunate households. But, that just makes it worse on everyone else. When you get to a point where the only way to survive in a city is to either make six-figures or to get below market rate housing, then it really does look like market-based solutions only help the rich and state-based solutions help the poor, because effectively any poor family that could have benefitted from a functional housing market has already moved away to another city that does have a functional housing market. This leaves the Closed Access locals with the impression that their horrible policies are necessary.

  3. OT but related to earlier post of yours.

    I commented on Sumner's blog:

    "Add on:

    "Oct 26, 2017 - Nano flats, or apartments each smaller than 200 square feet, will be the new norm in Hong Kong as 2100 of such complexes are on drawing boards through 2020."


    Are Hong Kongers obtaining higher standards of living in the city-state frequently deferred to as the freest economy on Earth?

    So why the nano-flats?

    Are 100-sq-ft. flats in the future when even higher living standards are obtained?


    Earlier, you asked why people are buying houses on small lots in Phoenix, if land was not the key variable. I noted some of the housing developments of the Inland Empire housing tracts 1980s and 1990s already had to houses crammed together on tiny lots.

    Now, when one builds a condo tower in Hong Kong, I would guess the land is important (very expensive in HK), can be spread among many units. Why nano-flats?

    There must be something going on in economies of scale, consumer preferences, regulations, or what I call "situational leverage."

    Situational leverage is when in the Old West you came to a small town with one bar in it, after a long trail ride. You order a whiskey, and you know it is rot gut at Hyde Park prices, but the next town and bar is a 25-mile ride by horse. And no one dares open up another bar in town.

    So when there is constrained supply, the builders have situational leverage. They choose to maximize profits to the last dime and if that means cramming people together, and they can still sell their wares, then they do that (as I or you would if we were risking capital on a property development).

    It remains that orthodox macroeconomists keep hailing Hong Kong as the freest economy in the world. Something about property and property zoning----it is just off the radar of orthodox macroeconomists.