Liddick: Choking regulation
January 2, 2012
Merry New Year. The following is for anyone who is still having trouble connecting the dots on how regulation and taxation affect investment.
It’s a true story, but changes have been made to make it easier to follow, especially for those who believe we can tax people without limit and regulate businesses as we wish, without any collateral economic damage. I’ve used names from a popular work of fantasy, since they seem comfortable with that sort of world.
We begin in East Farthing, which was a humming industrial metropolis before stratospheric union wages, prohibitive tax rates and over-regulation drove the industries out of the town, out of the state, and to the brink of ruin. The two remaining activities are government – it is the capital of the state of – oh, let’s just say Shire – and education. The city is host to one of the best-known research universities around. It’s not Hogwarts, but it’s close.
Needless to say, the real estate market of East Farthing has been very badly affected by the years-long downturn in the national economy – on top of the blow struck by the above-mentioned factory closings and shuttering of a myriad of associated businesses, from parts and uniform makers to hot dog vendors. Wave after wave of foreclosures struck; in some neighborhoods, half the houses were abandoned. Values plummeted. And the pattern repeated in other cities across the Shire.
Tax revenues dried up, but demand for services continued and politicians were happy to oblige. The state teetered on the edge of bankruptcy. Major cities had to go into receivership. Urban blight spread like a prairie fire, and real estate values sank further.
Which interested the Gaffer. He saw the opportunity a depressed market offered. He could buy properties and rent them, offering university students – a ready market for rentals, particularly apartments – lodging at decent prices, making a modest income in the bargain. The formerly empty apartments would be filled with tenants, each of them consuming additional services – thus boosting the local economy and the tax rolls. The Gaffer would contribute too, paying property taxes. Everyone would win. Except …
Apparently, the town of East Farthing doesn’t like landlords: They are part of that reviled group, “the rich.” So they must be punished.
Taxes were the first step. East Farthing had some of the highest property taxes in the state, but that wasn’t the problem. The Gaffer recognized that property taxes paid for services, and the services were good. It was just part of the equation of risk and reward, and it was predictable, so he could set his rents accordingly. But then he discovered the “landlord surtax.” Because he would be renting the property, not occupying it, East Farthing would charge him 33 percent more than someone who wasn’t a landlord. And there was the probability that the state would begin taxing rental properties as well – it’s nearly broke. As it was, the surtax raised the rent he calculated he would have to charge to the limit of what the market would bear.
He also found that, if he wanted to purchase a property and rent it out he would have to obtain a license to do so from the city. But earlier in the year, the city stopped issuing licenses, and no one could tell him if they had begun again. He was informed that the license would cost $1,500, if available. Plus a “first-time applicant fee” of $250. Plus an annual renewal fee of $250, or maybe more. He was also told he couldn’t apply for a license; the application had to come from the homeowners’ association of the condominium complexes in which he intended to buy. Having served on an HOA board or two, the Gaffer doubted they would be entirely helpful.
It was all too much. In addition to success depending on the expedient work of bureaucrats both civic and private, the Gaffer calculated he would have to charge far above market rate for properties he might rent; if he were to meet the market, he would be subsidizing his tenants. So there was no purchase; excessive taxation and an overabundance of regulation thwarted an opportunity. The properties in East Farthing remained empty, a drag on the real estate market. Prospective tenants missed the possibilities economic competition creates. The Gaffer missed a chance to make a profitable investment. The economic activity tenants might have generated were lost; the taxes that would have flowed to East Farthing from that activity were uncollected. Everyone loses.
Multiply this story a millionfold and one begins to understand what an overall corporate tax rate of about 47 percent and 219 new federal rules covering everything from truck transportation to water quality will do to an economy. Something worth remembering as we hope for change in 2012.
Summit County resident Morgan Liddick pens a Tuesday column. E-mail him at email@example.com.