Unintended Consequences?

I am returning to the theme of Housing for this post, but will concentrate exclusively on the rental sector.  Oxford City Council have introduced new licensing conditions on what are called Houses of Multiple Occupancy (HMOs).  Nationally, an HMO needs to be licensed if it is "large" and is considered to be "large" if:

• There are five or more tenants.
• the house has three or more floors.

See the relevant part of DirectGov.  

However in Oxford, the Council has decided to tighten these regulations.  They will consider an HMO to require a license if:

• There are more than two tenants.
• The house has two or more floors.

The licensing system in Oxford is not being funded by the general tax payer, but by a system of fees on the HMO licenses themselves.  The fee is proportional to the size of the house in question, but can rise to around £500.

So what will be the economic effects of this policy.  First, in the short run, landlords who do apply for the license will actually be unable to pass the tax on to their tenants!  This might well be surprising for some, but the economic logic here is as follows.  The scarcity of housing means that landlords are effectively already extracting from their tenants the maximum willingness to pay of each tenant.  So there is no room to extract more.  However, in the longer run, landlords may decide that the bureaucratic costs of applying for the licenses and making any changes that the council requires as a result are just too great and stop renting their properties to multiple tenants.  Indeed, this is just what seems to be happening in this story from the Oxford Mail.

Once landlords start leaving the HMO market, then rents will rise as the (already too small) supply of rental housing contracts.  But what happens to the houses that were being rented as HMOs?  Will they be rented or sold to families and singletons?  Will this drive down the rents or prices that families and singletons have to pay?  Unlikely.  The fundamental problem of scarce housing still exists.  Indeed, high housing costs are one of the reasons that people delay starting families and live with friends in HMOs for longer.

It is more likely that in order to extract maximum value from their properties, landlords will instead divide them up.  They will turn each floor into a separate flat with its own toilet and kitchen facilities etc, so that they are not HMOs and rent out the floors separately.  In order to create the extra kitchens and bathrooms this will require, the total number of bedrooms will fall.  So the total housing supply falls leading to higher rents for the younger people starting out in life who will be renting these properties.  Naturally this process will take time; cost money; and require planning permission.  But if the council is serious about limiting HMOs (see below), it may well become the best option for those who own homes in Oxford.

For tenants forced out of their homes, this is a tragedy.  Such consequences of a policy are often referred to as "unintended consequences", this is the term used in the Oxford Mail story.  However in this case, the consequences are so transparently obvious that it is difficult to call them "unintended".  Indeed a brief perusal of Oxford City's website and the website of the local political party that controls it reveals that, far from being an unintended consequence, forcing out people like the tenants from the Oxford Mail's story is the point!  Note that Oxford City's website includes a section "Why are HMOs a problem in Oxford?"  The phrasing of the question itself reveals more information than the answer.  The controlling party boasts of having "... taken action to ensure local communities have a balance of housing, rather than HMOs taking over entire areas."  The prejudice against HMOs and the young people who normally live in them is clear.

Why is the local council trying to reduce the number of HMOs?  Oxford City's website highlights two general problems with HMOs.  To paraphrase:

• Across the entire country, the landlords can be a bit dodgy and neglect safety issues.
• There tend to be a lot of complaints about the people who live in them.

There is no satisfactory reason why we should expect that the first problem is unique to HMOs.  Indeed it shows a somewhat disturbing set of priorities in some respects.  If a dodgy landlord doesn't get the boiler checked we want to stop them renting to a group of young professionals or students and would rather they rented to a family?  Really?  Wouldn't it be better to ensure that all tenants knew their rights and that they could demand that the landlord get an annual gas safety certificate?  Wouldn't it be better to encourage tenants to report anything in their property that was unsafe?  (To align incentives, they could be encouraged to do so at the end of a tenancy during negotiations over return of the deposit).  If the point of these rules is really to help tenants, it strikes me that evicting them is an "innovative" strategy.

Regarding the second issue, the council are being exceptionally short sighted and this is possibly a case of unintended consequences.  From this perspective, the problem of HMOs is not the houses or the landlords, but the people who rent them.  The people who rent them are unlikely to leave Oxford and camp outside the ring road.  Rather it is more likely, in the long run, that they will be the people who rent the same houses again once they have been converted into flats.  In that event, I would expect the number of complaints to actually increase.  Currently entire houses are rented and people who live in them know each other.  Noise travels between the floors, but differences and arguments about this can be worked out between the various house mates who all know each other and are friends.  Friends are able to resolve these differences relatively amicably.  The noise externality is "internalised" in economics speak.  However once these houses have been converted into separate flats, noise will still travel between them, but the people who live in the different flats won't know each other and won't be friends.  They are therefore more likely to involve the council in disputes about noise and so on.  This policy will further reduce community cohesion rather than increase it!

I once thought National policy on Housing in the UK was misguided.  (See previous post on housing).  Compared to some local policies, it now appears positively insightful.  And that is saying something...

Cash in Hand

David Gauke, a minor Treasury Minister from the Conservative side of the coalition has said it is "morally wrong" to pay cash in hand seeking a discount.  This did not actually have the connotation of a pronouncement from on high that some of the later press coverage has imputed.  The minister was answering questions after a speech.  The phrase "morally wrong" was not chosen by the minister, it was chosen by the journalist asking the question.  The minister seems to have been saying (somewhat clumsily) two things:

1. People should not ask for a discount if they pay in cash in the knowledge that the tradesman will use the cash without declaring it; and
2. Stopping tax avoidance is important, but the "hidden economy" is a "very substantial" part of it as well.

One of these points is interesting; the other is mundane.  The attention each has received looks to me to be the wrong way around and that says something about us and our priorities.

The mundane point is that people should not say to their plumber or cleaner something along the lines of "I'll pay you in cash; you then don't need to report the income; and you can give me a share of the money you save on taxes through a discount from your usual rate".  As statements go, it is difficult to see why this has attracted the attention it has.  All it is really saying is that you shouldn't ask someone to commit a crime on your behalf, albeit a relatively minor one given the amounts involved.

Note that this is quite different from what I suspect usually happens when cash in hand payments go undeclared, which is where the tradesman offers a discount if you pay in cash.  This is a bit more of a grey area.  Not being a Philosopher, I think I'll leave off this point and move onto the second part of what the minister was (mis)communicating.

The minister was saying that stopping tax avoidance schemes at the top of the income distribution was important, but the hidden economy of tax evading plumbers and cleaners is just as important.  There was a sense in which the minister was equating the two and suggesting that if we are going to crackdown on one, we should also crackdown on the other.  Again, as I am not a Philosopher, I shall leave the ethical analysis to others and just consider the economics of this statement - in economic terms, this is palpable nonsense!

According to the HMRC, the median income is approximately £19,600 per year.  Whereas the income of the 99th percentile (this is the minimum income to claim membership of the top 1%) is £149,000.  The post-tax median income is £17,200.  The post-tax income of someone at the 99th percentile is £105,000.  A very rough and ready calculation (assuming the order of taxpayers remains the same before and after tax) suggests that the median taxpayer pays £2,400 per year in tax and the taxpayer at the 99th percentile pays £44,000 per year in tax.  So (on a very rough and ready calculation) catching a tax avoider or evader at the top of the income distribution will recover for the Treasury more than 18 times as much money as catching a tax avoider or evader in the  middle of the income distribution.  So the minister is right only if with the same effort and cost that it takes to catch one tax avoider at the top of the income distribution, we could catch around 20 tax avoiders in the middle of the distribution.  This may in fact be the case, and so there may be greater net benefit to the treasury from going after tax avoiders in the middle of the distribution, but that needs to be part of the discussion and it wasn't.

There are, of course, factors which should be considered but have been left out of this analysis for lack of data.  One example that would make the calculations even less favourable for the Minister is that we shouldn't be comparing the 99th percentile with the median, but the mid-point of the top 1% with the 25th percentile which might have a higher concentration of self-employed tradespeople.  That would put a much higher threshold on how much easier it would have to be to catch people at the lower end of the income scale in order to make targeting them worthwhile.  However, in the Minister's favour, there are a greater number of people at lower points of the income scale, and there may be economies of scale in targeting these groups that improve the economic argument for doing so.  There may be some reason to believe that tax evasion is more common at lower income brackets, though the Minister has not stated any reasons why we might think this, but if it were the case, that would change the analysis somewhat.  Some combination of these two points seems to have been what the Minister was driving at when he referred to "the hidden economy" being a "very substantial" part of the problem.  Although this does raise the question: If this part of the economy is "hidden", how do we know how big it is?

There is one final point to consider in all of this and I shall have to try not to sound too much like I am gloating.  The ideas of providing a "Nudge" to effect change described in the book of that name by Thaler and Sunstein have apparently been influential in Downing Street.  The idea is one that can work well when there is a behavioural bias to be overcome.  Increasing pensions savings by making pension schemes "opt-out" rather than "opt-in" is a good example.  One could (generously) read David Gauke's statement as an attempt to nudge the population into not accepting "cash in hand" discounts and even reporting tradespeople who suggest it.  If  that is the case, then it would seem to have backfired.  Nudges work best when they overcome a behavioural bias and point us in the direction of our own interest.  A Nudge will have a great deal of difficulty in getting us to take actions which run counter to our own interests.