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I respectfully ask the Berkeley Tenant's Union to reconsider and reverse its endorsement of a proposed increase on the Business License Fee assessment on gross revenues from residential rents. 

This note is divided into four parts: 

In part 1 I will briefly review some facts about the incidence of such a tax -- who pays the tax and how. 

In part 2, turning to the conditions specific to Berkeley, I point out strong indications that the tax increase will mostly likely harm tenants, workers, and Berkeley's capacity to regulate new development. 

Further, while the proposed tax is meant to increase public funds available for affordable housing projects, countervailing effects must be taken into account: it is far from clear the tax will increase rather than decrease the number of affordable units created in the future. 

In part 3 I will examine the arguments BTU has made in favor of the tax, pointing out some flaws in these arguments. 

In part 4 I will suggest alternatives to the proposed tax. 

 

Part 1: Incidence of taxes on rent. 

In Berkeley, residential landlords must obtain a business license from the city. As part of payment for such a license, landlords are assessed 1.081% of gross receipts. (E.g., a $1,500 per month unit currently produces $16.22 per month in tax.) 

The proposal before City Council is to increase the assessment of gross receipts from 1.081% to some amount between 1.8% and 4.9%. 

Proposers estimate that this increase would increase the taxes per month, per unit by between $30 and $60 on average. 

Annualizing the increase ($360 to $720 per unit per year) makes it clear that the amount is far from trivial. 

The question arises? Who will pay? Landlords? Renters? Someone else? (What is the "incidence" of such a tax?) 

Predicting the incidence of tax on rents of real property is notoriously difficult but some general rules can be stated: 

1. In the short run the burden of any new tax falls on the party least able to shift the burden to another party. 

1a. Landlords may have options to shift the tax to tenants, employees, or the public. Landlords can shift the tax directly: rent increases on tenants or wage reductions on workers. 

Landlords can shift the tax indirectly: reductions in services to tenants or high productivity requirements on workers. 

Landlords automatically shift a portion of the tax to the public because the additional revenue collected by the city is no longer taxable by the state or federal government. 

1b. Tenants may be able to resist the tax burden if standing tenants move and new potential tenants decline to pay higher rents. 

1c. Workers may be able to resist the tax burden if they can seek jobs elsewhere or refuse demands to intensify their labor to raise productivity. 

1d. Of particular note for Berkeley: regulation may limit a landlord's option to shift the burden of a tax. 

2. In the longer term, a tax may become capitalized, which is to say it may absorbed as a decrease in the value of real property effected by the tax. This in turn has effects on the future course of development. 

Part 2: Tax incidence in Berkeley, 2015 and in the future 

In part 1 I produced a list of factors that may allow a landlord to shift the burden of the proposed tax, as well as countervailing factors that may prevent the tax from being shifted. 

In part 2 I will examine each of those factors from the particular perspective of Berkeley. The factors to be examined are: 

1. Landlord options to shift the tax by rent increases.
2. Landlord options to shift the tax by service reductions.
3. Landlord options to shift the tax by wage decreases.
4. Landlord options to shift the tax by intensifying work.
5. Tenant options to move.
6. Worker options to quit or refuse job intensification.
7. Capitalization of rent-tax increases.

One by one: 

1. "Landlord options to shift the tax by rent increases." 

1a. Uncontrolled and vacancy-decontrolled units 

Since the crisis of 2008, Berkeley landlords of uncontrolled rental units have been trying hard to discover an upper bound on rents but there is no sign they have yet found it. 

Month over month rents have been climbing faster than inflation, and faster than regional household incomes. 

Rental bidding wars appear to be (in my eyes, at least) the exception, not the rule in Berkeley. There are no anecdotal indications that many new tenants are paying below advertised rent "asks". 

Consequently, it appears that Berkeley landlords are gradually discovering how high rents can go and that they haven't yet found it. 

In this circumstance, it should be easy to pass through the tax increase in uncontrolled units. For example, consider an uncontrolled unit renting for $2,500 / month. 

A 2% tax, passed through, would raise the rent by $50/month. 

It is implausible, in that example, that tenants could leave to save $50/month (and go where?) or that no new tenants could be found at $2,550. 

Students overcrowded into such a unit, or a family, would have little choice but to cough up the extra $600 per year. 

1b. Controlled units. 

A large number of Berkeley units would be subject to the tax but are also price controlled by the rent stabilization ordinance. 

Under the ordinance, rent increases normally may take effect only once per year and may not raise rent above a ceiling imposed by the City. The rental ceiling is annually increased by 65% of measure of the regional cost of living. 

On its face that would seem to prevent landlords from passing through the tax as a rent increase but this is not obviously the case. 

Berkeley's Rent Stabilization Ordinance would seem to prevent a simple pass-through but this conclusion must be qualified. 

Provision 13.76.120 allows a landlord to apply for adjustments to the ceiling, including adjustments to compensate for "Unavoidable increases or any decreases in maintenance and operating expenses". (13.76.120(C)) 

(Other provisions of 13.76 ensure landlords a right to a consolidated hearing for adjustments to all similarly impacted units.) 

The rent stabilization board's examiner must judge individual adjustments on the basis of a "fair return" on the landlord's expenses. 

"Fair return" is not directly defined in the ordinance but has a complex history in California courts. 

Landlords would appear to have a very good case that: 

• The Annual General Adjustment to rent ceilings tends to hover around 2%.
• The proposed business license tax increase would completely eradicate a full year's adjustment.
• The level of adjustment is designed to preserve a "fair return".
• Therefore an individual adjustment upwards is necessary to preserve a fair return.

NOTE! If the rent stabilization board attempts to systematically decline this pass through, it is plausible that landlords (e.g., perhaps acting through the newly formed political action and legal defense fund), will challenge the ordinance vigorously in court. Raising taxes on rent incomes would seem to raise the legal peril to this very important ordinance. 

2. "Landlord options to shift the tax by service reductions." 

Becoming a landlord is, in almost every case, a long-term investment. 

Literature that offers advice to landlords and potential landlords focuses on rate of return as a measure of business success. 

A landlord's typical goal is not usually to maximize their short-term profit but, rather, to sustain a good, stable rate of return on investment. 

A new tax on rental revenues first appears as a drop in each landlord's rate of return. 

All landlords will tend to seek ways to shift the burden of that tax, in order to restore their rate of return. 

Service reductions to tenants are one way for landlords to proceed. These may include (to give some examples): 

• Reducing the hours of on-call service.
• Increasing fees for amenities such as laundry and (unbundled) parking.
• Reducing aesthetic expenditures such as landscaping or frequency of garbage collection.
• Increasing the length of time it takes to answer maintenance requests.
• Downgrading fixtures (e.g., stoves and refrigerators) when replacing them.
• Increasing penalty fees (late rent, bounced check, etc.)
• Increasing pet fees.

In these cases, although tenants are not literally paying more in rent, the landlord has still achieved pass through by spending less per tenant, to the tenant's detriment. 

3. "Landlord options to shift the tax by wage decreases."
4. "Landlord options to shift the tax by intensifying work." 

Landlords who control more than a few units rely on direct and indirect employees to manage properties and provide basic services to tenants. 

Faced with a tax increase, landlords have the option to make due with fewer employees, or to offer smaller raises, or to replace tenured employees with lower-wage replacements. 

5. "Tenant options to move (with no tenant to replace them)."
6. "Worker options to quit or refuse job intensification." 

Against all of the above options for a landlord to shift the burden of a tax to tenants and workers, we have but two these countervailing pressures, neither of which is plausible. 

7. "Capitalization of rent-tax increases." 

If Berkeley's effective taxes on rental income are higher than those in the region, the difference will appear as a relative reduction in Berkeley property values (of the taxed properties). 

At first glance that may seem absurd since, no matter what, Berkeley's property values tend to be higher than most of the region. Nevertheless, the property value detriment of a new tax can still have significant impact on city policy. 

While the effect is hard to quantify, the addition to rental operating expenses makes it harder to justify investing in new Berkeley development (rather than investing in a nearby city). 

In Berkeley, because of the structure of our land-use regulation ordinances, an increase in rental operating expenses per unit raises the demands developers can make on the city for a proposed project. 

Negotiations concerning zoning variances, community benefits, and affordable housing mitigations often invoke the issue of "viability". A developer can make stronger demands if, otherwise, a project would not be "viable". 

In short, what Berkeley might gain in the short term from a tax on rental revenues it will easily lose in the future in concessions to developers as a result of that extra tax. 

 

Part 3: Examining the Berkeley Tenant's Union Position Statement 

In reply to my inquiry, the Berkeley Tenants Union replied with a statement of their endorsement for the tax increase, and their arguments for that endorsement. 

I will now examine these arguments. 

The central BTU claim I dispute is this: 

"It will tax landlords' windfall profits from rising rents without harming tenants." 

In part 2 I believe I offered substantial reason to believe otherwise. It is easy for landlords to shift the burden of the new tax; hard for tenants and workers not to bear the brunt. 

Why does BTU think otherwise? 

BTU says: 

"It is certainly true that the landlord uses the tenants' money to pay the tax, just as they use the tenants' money to pay their mortgage and insurance and for their own profits. But the tax can only harm tenants if the landlord can raise their rents even more than they already do." 

As noted above, landlords can seek to recoup the tax through reductions of service that harm present tenants. Developers can seek to recoup the tax through more stringent demands for new projects, harming future tenants. 

BTU appears to be myopically focusing on the alleged prospect of $2M to $3M annually added to the affordable housing trust fund; a rate of trust fund income that will produce very little actually affordable housing any time soon. 

BTU continues: 

"The landlord can't [pass through as a rent increase], and here's why." 

"First, most Berkeley tenants are covered by rent control. The landlord can only increase the rent by 65% of the increase in the Consumer Price Index. The landlord cannot increase the rent just because the taxes go up." 

In fact, the stabilization ordinance gives the right for landlords to preserve a fair rate of return through individual adjustments to the rent ceiling. 

The Rent Stabilization Board is charged with a duty to provide owners of many units with an efficient, consolidated hearing. 

The Rent Stabilization Board can not interpret the ordinance so as to constructively deny landlords their AGA adjustment. 

"But what about when the current tenant moves out and a new tenant moves in? Can't the landlord raise the rent then? Yes, they can, but they already do. Landlords already raise the rent to the maximum the market will bear. They can't raise it any higher than that." 

Since Berkeley rents charged do not commonly exceed the "asks" of landlords (bidding wars aren't common here), it remains likely that the market can bear more than what is currently being charged. 

Sadly. 

"What about tenants whose home is not covered by rent control? There are two main groups of tenants who rent from for-profit landlords and are not covered by rent control, those in single-family houses and certain duplexes and those in newer apartment buildings built after 1980. One and two-unit properties are exempt from the tax, so those landlords are not affected by it." 

On this point we agree, although rent increases in other units make it easier to charge higher rents in those exempt units. 

"In the new apartment buildings, we all know that the landlords raise the rent as fast as they can, sometimes even more than a year." 

That's because they haven't yet discovered the top of the market. 

Because of the state of the global economy, it is unclear that there is a top to the market. 

"They already charge the maximum the market will bear," 

That statement contradicts BTU's own observation that rents increase month over month. 

"and they can't raise it any higher than that." 

BTU here asserts that (for example), a $60 per month increase at a large downtown apartment building will send tenants fleeing and make it nearly impossible to find replacements. 

Does that sound even remotely plausible? 

No. On the contrary. Tenants will just be losing more of their income to rent. 

BTU chides: 

"This is basic economics. If there is lots of supply of a retail good, such as heirloom tomatoes, then competition between the suppliers keeps the price down to the minimum price necessary to cover the costs of producing the tomatoes and providing the producer with enough profit to stay in business. Then, if taxes go up, the price has to go up to cover the costs. But apartments in Berkeley rent for double the national average, far above the minimum necessary to profitably operate and maintain the buildings. Anywhere from half to a third of the rent is paid not for the physical apartment but for the location, the privilege of living in Berkeley." 

That is not "basic economics", it is a fallacy. 

To put it in folksy terms: 

If taxes start to hurt heirloom tomato buyers, those buyers easily seek substitutes. 

If taxes start to hurt Berkeley renters, too bad. In most cases, moving will be an even worse option. Even if people are forced out of their homes by this tax, replacements are waiting in the wings. 

(Aside: Rule of thumb -- any argument that begins "This is basic economics," is almost certainly false.) 

BTU concludes: 

"BOTTOM LINE: Landlords already charge as much as they possibly can. If they could charge tenant an extra 2% or 4% to cover this tax, THEY WOULD ALREADY BE DOING IT." 

BTU simply has no basis for that implausible assertion. 

In fact, BTU says itself that rents are going up month over month -- a fact that says landlords have not yet discovered the top of the market. 

part 4: Alternatives to endorsing the proposed tax. 

As I'm sure current members know, the name "Berkeley Tenants Union" had a lot of punch in the 1970s. 

Today's BTU is caught up in the soap-opera drama of RSB elections and proposed ordinances but it is a shadow of its former self. 

The time is ripe to do what unions must do and organize. 

Beyond repudiating the proposed increase in tax on rent income, I hope BTU can find a way to organize tenants in preparations for not just better endorsements, but better actions. 

In solidarity is strength. 

BTU will be once again a union when it organizes the residents of a property like Library Gardens. 

BTU will once again be a union when students can collectively bargain for school-year rentals (kept in good repair, no less). 

BTU will be a strong union when a large membership can be called upon to help defend a weak individual tenant who is under threat. 

BTU should be more than a de facto PAC, if you ask me.