For years, taxpayers have provided significant, direct, regressive transfer payments to real estate investors. The two primary forms of this have been the home mortgage interest deduction and special rules that apply to capital gains on a primary residence. These policies are large in size, so there is legitimate debate about whether it is good policy or not to redistribute wealth in such a manner. But one of the key aspects of these kinds of subsidies is that they are more or less permanent and predictable. They alter the relative value of real estate compared to other kinds of assets, but they don't create additional volatility or cost beyond this initial reallocation.
However, over the past few years, we have engaged in policies that don't just redistribute society's wealth. They create and exacerbate volatility that then leads to additional social costs beyond the immediate transfer payments. In particular, I am talking about artificially low interest rates, lax regulation and enforcement of laws (especially fraud), and temporary home buying tax credits, first as a $7,500 0% loan and more recently as an $8,000 handout. It's that last item I want to address this evening.
A couple weeks ago I explored conceptually how to approach the "first time homebuyer tax credit" from a political perspective, how the economics interacts with the policy application. While it is largely objective, you can likely read into my tone a general distaste for these kinds of redistributive policies. Here, I'm going to editorialize for a moment on this and then offer some approaches for what we can do about it. For the results-oriented gals and guys out there, or just those of you short on time, feel free to skip down to the last bolded header for specific suggestions.
Why is "First Time Homebuyer Tax Credit" in quotes? (if language isn't your thing, just skip to the next bold item...)
Our ability to communicate is dependent upon the language we have at our disposal, and politicians and financiers are exquisitely adept masters at understanding and employing this state of affairs for their benefit. The fascination with this program begins with the name itself. It is not simply for first time investors, the primary beneficiaries are not homebuyers, and it has nothing to do with the tax code.
In reality, the first time homebuyer tax credit is simply a phrase that's deployed to express a much larger and more complex program while making it sound like there's a specific, coherent principle supporting the effort. Eligibility is not based on whether one has bought a home before or not. Rather, eligibility is determined by whether one has recently owned a home or not. Now, this rhetorical trick isn't anything new. Just ask a friend, if you don't know, what a born again virgin is. The difference is semantics; very important semantics. Then, there's the little matter that homebuyers are one of the lesser beneficiaries of the policy. The bulk of the subsidy goes to the real estate industry itself, the Realtors(R), mortgage brokers, etc. Then, a significant chunk goes to the sellers. After all, the whole point of the policy is to stabilize the sales prices and number of sales. The people who benefit from this primarily are those who
- Are in the real estate business
- Own real estate and want to sell
Don't get me wrong, tax credit-eligible buyers get some benefit, depending upon their relative negotiating prowess in the particular transaction in question, but the reason for using homebuyer, instead of homeseller, [or Realtor(R)] is because, well, it sounds better, not because it has any explanatory value of the actual effects of the policy. In our private property, double-entry bookkeeping way of viewing the world, by definition, a transaction involves a buyer and a seller. There's no way to help sellers without hurting buyers (unless, of course, somebody else picks up the tab).
Which gets us to the third part of the phrase, tax credit. This has nothing to do with the tax code. Rather, it simply recognizes that the IRS is an extremely efficient, customer-oriented bureaucracy. Yes, you read that right. In fact, I'm going to let you read that sentence again to make sure it sank in [insert Jeopardy music here]. Rather than altering the tax code, the $8,000 tax credit simply employs the IRS' rather useful expertise to transfer $8,000 to eligible homebuyers. Calling it a tax credit is like calling a Halliburton contract a tax credit; it doesn't make sense because there's no relation between taxation (receipts) and spending (outlays). Now, that's not a bad thing per se, it's just valuable to see through the linguistic nuances. Nonrefundable tax credits are far superior to tax deductions. This is precisely because a nonrefundable tax credit has nothing to do with one's tax liability, one of the core drivers of the regressive nature of tax deductions generally. Wealthier people who buy bigger houses get more money (via policies like the home mortgage interest deduction and capital gains exemptions) than poorer people who buy smaller houses, even though they're both engaged in the same supposedly beneficial act, buying a house. That's only a good policy if you like McMansion sprawl and wealth concentration. Think about this the next time you read a story about the first time homebuyer tax credit, or housing industry subsidies more generally.
So you don't like housing subsidies? (if you just want to cut to the chase, skip to the next bold item...)
To be precise, what I do not like are regressive policies that misallocate resources within the housing industry and between housing and other asset classes. The opportunity cost, the social value of what is lost by favoring one asset class over another, is almost by definition greater than the private gain enjoyed by the beneficiaries of the policy. Affordable housing overall is a great public policy goal; home ownership specifically, though, is only valuable to the owners and people in the business of selling real estate. Conceptually, socialized losses and privatized gains works no better for individual home owners than big financial firms.
We all might have some altruistic (ie, human) sense of wanting to target specific goals, like trying to help a homeowner who is struggling, or trying to incentivize a renter who wouldn't otherwise buy a house to do so. The problem is how to do that. Calculated Risks' ongoing exploration of the policy has resulted in an ever-higher numerical estimate of the marginal cost of inducing one person to buy who would not otherwise have done so.
That cost for potential new extensions of the program is now exceeding $100,000 per additional home sold. I point that out mainly as an excuse to shemelessly reference my not-so-serious exploration of handing out gobs of money. I thought at the time $100,000 was a number so absurdly large and conveniently round that it would seem ludicrous, proving that no matter how much we may follow an issue, we have to be prepared to change our minds based on new evidence. Such is the cost of inhabiting the reality-based world.
The NAHB has also been arguing to expand the tax credit from $8,000 to $15,000. But using $8,000 per home buyer - and estimating 5 million home sales over the next year - the total cost of the tax credit would be $40 billion.
According to the NAHB this would result in 383,000 additional home sales. Dividing $40 billion by 383 thousand gives $104,400 per additional home sold!
One thing I will say in defense of the housing tax credits (both the previous $7,500 loan and the current $8,000 handout) is that they're done pretty well compared to other kinds of handouts because they get the money to their target, the real estate industry, rather effectively. The CARS (cash for clunkers) program provides an illuminating comparison, as it added several absurd restrictions that made the program much worse than the basic concept of transferring taxpayer dollars to private industry. Specifically, it
- required clunker owners to buy another vehicle.
- required that vehicle to be brand new.
- required destruction of the old vehicle.
- put into place very minor MPG requirements for the new vehicle.
- created a lot of paperwork, inventory, and cash flow issues for dealers involved in the program.
- created massive volatility from Q1 to Q2 to Q3 2009 due to the extremely short-term nature of the program.
This created such a hodge-podge of countering incentives that it really was just a massively ineffecient handout. It was neither good economic policy nor good manufacturing policy nor good environmental policy. It exacerbated volatility rather than smoothing it out, it ingrained low mileage vehicles rather than seeking new alternatives, and it transferred dollars that could have been spent elsewhere, on things like renewable energy and rail transportation.
And that observation gets to the heart of this particular post. If we're going to implement policies like this, let's at least make sure the details don't make things worse. In an ideal world, government wouldn't be picking winners and losers; that's what private property is all about. You might make money, you might lose money. But if government is going to get in that business, if we simply can't stop that politically, then there is also value in advocating for sensible guidelines for crafting these policies.
How can we improve the housing tax credit program?
The meat of the issue, with all apologies to herbivorous friends, is determining the desired outcome. It's critical that we define goals very clearly, because the lobbyists driving the legislation have their own goals, separate from what benefits either homeowners or society at large. Our goal should be increasing net demand for housing, not increasing the number of transactions.
The framework that has been laid out is pretty straightforward. Senator Isakson, in that regard, is doing us a good public service by being much more frank on this than advocates of the much larger and more secretive corporate bailouts of the past couple years.
Specifically, my legislation would increase the maximum amount of the credit from $8,000 to $15,000 and expand the current tax credit so that it applies to any buyer of any home, not just first-time buyers. My legislation also would eliminate the income caps of $75,000 for an individual and $150,000 for a couple under the current tax credit so that there is no income limit for eligibility. Finally, the legislation would extend the tax credit for one year from date of enactment and would still allow homebuyers to claim the credit on their 2009 tax return for purchases made in 2010.
Isakson even names the lobbyists.
My legislation has been endorsed by the U.S. Chamber of Commerce, National Association of Realtors, Business Roundtable Housing Working Group and Mortgage Bankers Association.
And he shows why it's not enough simply to say no to silly policies like this, no matter how silly they may be. They get through Congress, so we might as well try to make them better.
I am pleased the Senate has twice passed my proposal overwhelmingly, and I will continue to push this tax credit until it is signed into law.
So here we go. IF we continue the housing tax credits in their basic form, enough to be wasteful but not enough to do anything really bold and visionary, then these guidelines should either remain in place or be added:
- Don't eliminate the income limits for buyers.
This is one of the best features of the tax credit. High end luxury buyers are least influenced by a relatively small amount of money, and those areas are least in need of investment. Yes, I know. There are some very exclusive properties in places like DC, NY, LA, SF, HI, and so forth. The people buying those properties are doing just fine. There isn't that much of a relationship between median home prices and median incomes across broad geographic regions, while the greatest disparities in both real estate and wages occur not between the coasts and flyover country, but rather, within metropolitan areas. The simple fact is that if your household brings in more than $150,000 a year, you are one of the highest income households in your city, whether that city is San Francisco, CA or Des Moines, IA. To say that slightly differently, a 2,000 square foot house costs more in San Francisco not because of wage disparities but rather because land in the Bay Area is largely inelastic. The bay, the ocean, and the hills create natural barriers to sprawl that don't exist in, say, West Des Moines.
[I'll put my money where my mouth is on this, by the way. I'll bet a nice steak dinner (er, uh, chickenless chicken patty) that I could generate a list of median incomes and percent of households that make more than $100,000 by zip codes and you couldn't tell whether the data for those zip codes are in an 'expensive' city or cheaper one.]
- Target household formation.
Home owners selling to each other are a wash in the big picture; the only way to 'stabilize' demand is to increase the net number of home buyers, in other words, to make more households. To do this, I suggest creating a two-tiered system. The first tier would be a 'first time homebuyer' criteria. I would bump this to $10,000, and make it applicable specifically to first time buyers; no repeats who have previously owned. The second tier would be a 'first time household' credit, and it would be twice as large, $20,000. To be eligible for this, you would have to show that for some period of time (2 years, for example) you have shared a living arrangement with someone with whom you did not have a dependent relationship (for example, an adult child living with parents, roommates sharing a place, sisters who moved in together, etc). Having renters simply move down the street and buy doesn't do anything other than drive real estate commissions. But, splitting up households increases the total demand for the housing stock.
- Deal with the volatility created by temporary time frames.
While the homebuyer tax credits, which have stretched essentially over 12 month periods, are much better than the cash for clunkers, which was essentially measured in weeks, the temporary nature of the program still is problematic, both in a sense of efficiency and a sense of fairness. Therefore, the other purpose of the two-tiered system is to create another time frame: permanence. The second tier will be temporary, another year extension like that being advocated by the real estate industry, and in exchange for a more targeted pool, notice I'm willing to advocate an even higher amount for the tax credit.
But here's the real kicker. In order to smooth out the fluctuations, the short term volatility of guessing what politicians will do in the future, let's just make the first tier, the $10,000 credit, permanent. That allows people to calculate when it's most effective for them to take the credit, rather than trying to beat artificial timetables in legislation. Making it permanent also is a credible way to signal that that's it. There's not going to be a bigger round of handouts next year. This is the policy today, tomorrow, next month, next year, next decade. When Tier 2 expires at the end of 2010, the replacement is already there, transitioned into the system this year with this legislation.
- Don't add extraneous components.
Killing two birds with one stone is always great when it works. But sometimes, this results in confusing the incentives and rendering the results worse than separate, dedicated efforts. Cash for clunkers is the recent prime example of this. Let's keep the housing tax credit as a simple, straightforward, narrow program. If we desire other outcomes, put that in different legislation.
- Implement a five year vesting cycle.
Part of stabilizing neighborhoods is stabilizing them. To that end, the final point I would highlight is making the nonrefundable nature of the credit dependent upon staying in the home as a primary residence for a minimum of five years. Each year, 20% of the credit would be earned. If someone who received the $20,000 credit wanted to move after only three years, they would be allowed to move. But they would owe the first $8,000 from the sale of the property (40% of $20,000) back to the government.
Is this doable?
I think so. I think it transfers enough money to the real estate industry that they'd take it over the risk of not getting anything renewed.
But here I have to confess a lot of uncertainty. I don't know important people. When I leave voice messages with politicians as a citizen, I don't get return phone calls. When I send written correspondence, I get a form letter back. If I'm lucky.
But I also stubbornly, perhaps naively, believe that if enough people ask similar questions, make similar observations, we do make a difference. What I'm proposing is partly a bandaid, partly wasteful, partly more of the same limited view of thinking. But I think it's a good enough compromise it could get somewhere. I believe strongly that it is certainly an improvement over the current framework Senator Isakson, the NAR, the NAHB, the MBA, etc have advocated, but that this is also friendly enough to them to be politically palatable.
I would be excited to hear suggested edits or perhaps responses you get from political staff.