As of this evening (Monday), it seems that the Senate version of the housing bill will make it intact to the vote on tomorrow. And you know that I’m not a fan. I promised that I’d explain why I think it’s a bad idea. It’s taken a few extra days (yes, a plague of biblical proportions seems to have fallen on my house) but here goes…
The original bill, as passed in the fall, was a $7,500 federal income tax credit for “first time homebuyers” that had to be repaid over 15 years. In that way, it was like an interest free loan. Phaseouts apply for single taxpayers at $75,000 and married taxpayers at $150,000.
The second version of the bill, which was not made law but passed in the House, was to revoke the repayment requirement, and offer a straight $7,500 federal income tax credit for “first time homebuyer.”
The final (?) version of the bill, which is not yet law, is a $15,000 federal income tax credit with no repayment requirement. A key difference in this final version from the House version is that this credit is nonrefundable, meaning you can only receive the credit if owe federal income tax; the Senate bill would also allow taxpayers to tax the credit over a period of two years. The Senate version of the bill is not limited to “first time homebuyers” and will be effective as of the date the bill is signed into law. It would not be retroactive and it would last for one year. A repayment requirement would apply if the home is sold within two years.
Whew. So much wrong, I almost don’t know where to begin.
Let’s start with the obvious: who is buying these homes? You would think, from all of the incentives in this bill to encourage home buying, that the problem is one of demand. But that’s not true. The current housing crisis is not due to a lack of buyers, but a lack of qualified buyers. In the current economic crisis, there is a lack of housing credit. Even banks that have taken TARP money, ostensibly to free up assets in order to extend credit, are not offering credit as easily as before. Perhaps that’s a good thing. But the bottom line is that with limited mortgage credit available, home ownership will not increase, tax credit or no tax credit.
Which brings us to the next issue: how much are these homes? I’m betting about $15,000 more than they would be without the credits. Credits are dollar for dollar reductions in tax due (not like deductions which are reductions in taxable income). More or less, a tax credit is like a “dollars off” coupon. That means extra dollars in your pocket. Good, right? Well, wait a second. If I’m selling you a home and I think you’ll pay $150,000, what do you think I’ll ask for the home? Not $140,000. These tax credits will likely have the result of artificially inflating market prices – remember, sellers now understand that there’s a huge credit at play.
Think I’m kidding? The NY Times ran a great piece that linked the capital gains tax breaks for homeowners in 1997 to the “bubble” that contributed to the current crisis. The tax break is said to have created a “consumption binge”, encouraging folks to buy and sell more than they would have otherwise. The Times cites a recent study by an economist at the Federal Reserve suggested that the number of homes sold subject to the capital gains tax break was almost 17% higher over the last decade than it would have been without the law. Buyers who took advantage of the capital gains break also reported spending more money and buying “more house” than they might have otherwise – a choice which many later regretted.
Of course, the tax law in and of itself did not result in the fall of the housing market. There are a host of factors at play: poor lending practices, unpredictable interest rates and overconfidence in the market all contributed. But what the tax provision did is favor one asset, real estate, over all over assets. The bill didn’t encourage savings or other investments. It didn’t encourage small business owners to invest in their own businesses. The bill simply encouraged folks to buy (and sell) real estate. And isn’t this what we’re doing all over again?
Why aren’t we encouraging saving? Why aren’t we offering real tax incentives for small businesses? Why not encourage re-investments in other markets? Instead, we’ve again singled out real estate as the most important asset in our investment arsenal. And in the process, I think we’ve changed what it means to own a home. Buying and selling homes as assets is a recent development. Prior generations bought houses to live in, not sell.
Of course, it makes sense in the abstract. Home ownership in the US is the “American dream.” In fact, we already subsidize home ownership through a mortgage interest deduction that, according to the Tax Foundation, will cost the government $100 billion for 2008. That is nearly half, annually, of what taxpayers are expected to contribute to rescue Freddie Mac and Fannie Mae. It is nearly ten times more each year than the entire housing bailout is estimated to cost taxpayers. But we don’t mind because that deduction benefits all Americans, right? Nope. Only about 30% of American taxpayers claim the deduction on their tax returns. Statistically, not overwhelming. Yet, we continue to push the idea of home ownership through tax policy.
By linking home ownership to the American dream, we’ve come to equate home ownership with the idea of prosperity. But here’s some food for thought. Home ownership in the US traditionally hovers about 70% – less than that of Mexico and India, nations that most believe are less prosperous than the US. That number is also far above the home ownership rates in Japan and Germany, which (at least before the global plunge) most would argue are countries with thriving economies.
So this all begs the question: why make home ownership the cornerstone of our economic revival?
We talk about trying to encourage those who could not otherwise do so to “follow the American dream” and purchase a home as if it will make everything better. The reality is, however, that this tax credit (as with the mortgage interest deduction) does not facilitate access to affordable housing for most Americans and it may do more harm than good. I’ve said before – and I’ll say it again – following the spectacular fall of the real estate market, perhaps it’s wise to reconsider whether promoting home ownership through tax policy is really the best use of our government dollars. What do you think?
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