Weird and worrying rate increase proposal

According to News24, a proposed amendment to the Municipal Property Rates Act will see rates on rental properties levied at business rates rather than residential rates.

I don’t have all the figures, but from the examples given this could be a tripling of rates in some cases, taking rates from less than half percentage yield reduction to significantly more than a percentage in many cases. Given common rental yields of, say, 6% for a flat in Joburg, this could be as much as a 15% decline in net rental income.

This must translate into either:

  1. a 15% reduction in house prices to provide the same net rental yield to investors;
  2. a 15% increase in rentals (with a corresponding devastating impact on defaults on rentals, voids / availability of tenants, direct and wage-push impacts on CPI inflation and increased transport costs as tenants search for cheaper rental properties further away from central areas; or
  3. some mixture of the two.

Who bears the burden of the increased tax?

I cannot imagine a scenario where the cost of provision of services will be higher for a rented residential property than for a owner-occupied residential property. Therefore, the increase must be designed as a way of simply increasing tax revenue and shifting the tax burden from one group to another.

Now that’s not automatically a problem – it’s the sort of decision around taxes I regularly blog about as needing to be made. The problem with this is, who is now bearing the burden of the tax increase and is it positive for our economy and public finances?

It might partly be a tax on property investors, which might be appropriate in our government’s eyes since these will be typically wealthy, high-income earners. (Although we already have capital gains tax and residential properties already don’t benefit from the significant deduction for an owner-occupied property, so one must be careful of attacking the same problem from too many different angles.)

But the tenants are also effectively going to be paying tax through higher rentals. Higher rentals will come through an increase in rentals charge to recoup some of the rate increases. Further, as rental property becomes less attractive, fewer rental properties will exist, pushing rentals up again to the point where investors receive a fair, after-tax return. We now have higher rentals and a more limited supply of property.

All of this is typical of the debt-weight loss from taxes taught in first year economics. Taxes reduce consumer and producer surpluses acting as a drain on the economy. This is before we consider second-order impacts of higher transport costs for tenants living further away – costs of transport, pollution, congestion and reduced employment.

There are a myriad other issues to consider – downwards pressure on property prices reduces transfer duties, which actually reduces revenue for the state. It is not inconceivable for National Treasury to announce an increase in transfer duties, but it would look a little silly after all the pushes to decrease transfer duties over the past few years.

A reduction in economic activity, lowered economic growth

A decline in property prices, through a wealth effect, would like lead to decreased consumption, lowering demand in the economy and adding more cyclical unemployment to our already potent cocktail of massive structural unemployment and some cyclical unemployment.

Adding pressure to our banks lending abilities

Defaults on existing loans to bank will increase, placing pressure on banks, which will likely reduce their enthusiasm for lending. Again, a reduction in economic activity as a result. Further repossessed properties (adding to all those put on the market because net rental yields are not attractive) will push property prices down further.

Will the extra revenue even be that much?

The additional revenue collected by government is likely far less than their estimates, since the natural result will be a reduction in properties purposed as rental properties.  On top of that is the additional complexity of levying rates based on use, which will probably result in additional non-compliance further decrease tax revenues and incurring costs to check for compliance.

The final result?

  • Increased rents
  • Decreased rental yields
  • A move away from investing in property to investing in equities and offshore investments
  • A hit on banks and decreased lending
  • Decline in transfer duties, possibly CGT and less-than-expected increase in revenue from higher rates
  • Increased transport costs and related negative impacts for employment and economic growth

So why doesn’t government focus on collecting the rates already owed to it as a starting point?

 

5 Replies to “Weird and worrying rate increase proposal”

    1. There isn’t really a new requirement – the same way capital gain is different for rented vs owner-occupied properties. But as I mentioned, there will be non-compliance and there will be wasteful expenditure on attempts at enforcement.

  1. How much would they really even earn with this counterproductive idea? If you can deduct property rates for rental properties from your taxable income, then that just cuts down the state again. As with most ideas though up at one of the ANC`s open bar conferences, the idea seems to something that can mentioned in an election speech to give the masses the idea that the rich are being punished, while in fact the tenants will be the ones who suffer most.

    Great article btw.

      1. Agreed, I have 40 tenants in the R1500 – R2500 bracket, the rate increase alone will add approx 10% to each of their rents, which comes on top of the 20% electricity increase and standard inflation. Add to that the fact that investors now need to actually generate a return on the rent and can not just rent the property while waiting for capital gains. Hurting those who really cant afford to be hurt.

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