By Shubham Paliwal
Demand and supply mismatch created by price ceilings causes poor and reduced accommodation for the lower income people.
The ‘Bombay Rents, Hotel and lodging House Rates Control Act, 1947’ served its purpose in the short term but in the longer term it led to reduced supply of houses for rents, dilapidated houses, black income and reduced taxes to the government. The rent control act should have been modified and the second generation rent controls should have been adopted as was done by many European countries.
The ‘Bombay Rents, Hotel and lodging House Rates Control Act’ was introduced because of the acute shortage of houses in Bombay due to the world war and partition of colonial India. The purpose of the act was to prevent exploitation of the tenants and to prevent speculation. The prices were kept low to provide relief to the city’s migrants after the partition. It was supposed to benefit the tenants.
Under it, the state put a cap on the amount of rent a tenant paid to a landlord, and this amount remained virtually frozen irrespective of inflation and the consistent rise in the market rates over time. Rents at about 19,000 buildings were set at 1940 levels to prevent owners from charging excessive rates during a time of distress.
In its initial years, the system served the purpose of creating affordable housing at stable rents but it failed in its purpose in the long run. It did help the tenants but it led to market distortion and negatively affected the interests of the landlords. The prolonged continuation of first generation rent control law led to various unintended consequences.
It led to a consistent degradation of housing stock because builders and developers had no incentive to generate more rental housing (as the rents were much lower than the prevailing market rates). Thus, almost all new housing being built was for ownership purposes (most of it for the upper-middle classes and above). Rent controlled buildings were often unkempt and dilapidated because the nominal rents did not motivate landlords to spend on maintenance.
An amendment to the Rent Control Act in 1999 allowed flats to be rented out, without rent control, on a leave-and-license basis for one year at a time. This lead to surge in the prices of uncontrolled rental properties due to market distortion created by the shortage of housing stock being built for rental purposes.
Rent controls gave rise to the informal pagdi (or pugri) system, where tenancy is transferred from one tenant to another at property rates a little below prevailing market rates and the landlord and tenants both have a share in it. As tenants held capital in the form of black money (share in pagri) the central government could not levy wealth tax and capital gain tax on it. Moreover municipal taxes were linked with rent, therefore, along with freezing of rent, income of municipality also got frozen and fixed. In order to make up for increasing service expenses, the municipality levied a tax as high as 142%, repair tax 402% (residential) and 755% (non-residential) for buildings repaired by the repair board. The pagdi amount being in black money led to increased investments in illegal trades and business. Even though landlords got tax free black money income on every transfer of tenants, they shuddered away their responsibility of repairing buildings on the plea of meager rent income.
Thousands of rent-controlled tenants are becoming millionaires as developers tear down crumbling colonial mansions to build luxury towers for the rich and pay huge sums to the tenants to vacate the apartments. In suburban areas, where old chawls were demolished by builders for new houses, old tenants of chawls were given free flats worth lakhs in the new building as alternate accommodation. A large section of the tenants got premises for residence and business at ridiculously low rates.
Tenancy rights continued even after the collapse of a 100 year old building. Old houses started collapsing for want of proper maintenance and repair. Instead of amending the Act, repair cess act was introduced under which landlords were exempted from liability to repair buildings and tenants paid repair cess upto 400 to 700%.
With rent control in place, people are lined up for housing, and therefore, the landlord can discriminate on the basis of who will take the most meager accommodations.
Price ceilings set below the equilibrium price arrived at through supply and demand, increase the demand for apartments. Landlords decide to withdraw from the market as they do not receive the full amount that they would be able to charge in a free market, for example by selling apartments and investing elsewhere. The supply of accommodation is therefore reduced leading to queues and waiting lists for apartments caused by the increase in demand. Some landlords may impose certain criteria on the tenants they accept, causing discrimination against certain categories of tenant.
Thus, overall the rent control act was beneficial only in the short term for the economy. In the long term it prevented modernization and led to increase in black money at the cost of taxes that the government could have collected and used for other purposes. It led to market distortion by creating a mismatch in the supply and demand of houses. The benefits accrued by the tenants were way more than was desired or necessary, the loss to the economy in terms of taxes was huge and thus it was not a wise move by the government. The government should have modified the rent control law much before by learning from the experiences of other economies.
Tenancy rent controls (also known as second-generation rent controls) are much more common in the contemporary world. One important feature is the “vacancy decontrol” provision which frees landlords to set rents freely once a rental unit becomes vacant. The amount of rent increase a landlord can impose on a sitting tenant is also limited. It also regulates or prohibits the practice of collecting nonrefundable deposits, limits the ability of landlords to evict sitting tenants, and restricts the use of fixed-term contracts.
Shubham Paliwal is a part of the GCPP’13 cohort at the Takshashila Institute.
[This and the other three essays on Price Controls was submitted as part of the Economic Reasoning coursework. Students were asked to identify instances of price controls in the world; who the intended beneficiaries were; and what were the unintended consequences of the price control. The 4 best answers were picked. The other three were on Price Control on Prescription Drugs in Europe and Price Control on Milk Products in Vietnam, Price Control on Gasoline in the US].