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Free Liberal: Coordinating towards higher values

Free Liberal

Coordinating towards higher values

Tax Credit for House Buying -- Good or Bad?

Not everything that sounds good is good

by Fred E. Foldvary

The Housing and Economic Recovery Act of 2008 (HERA) gives some house buyers an interest-free loan for buying a house. A married couple can reduce their federal income taxes in 2008 and 2009 by a maximum of $7500, for a total of $15,000 as tax credits. A single taxpayer gets half the credit. One is eligible if one did not own one’s residence during the previous three years. To qualify, one has to have bought the house after April 8, 2008, and before July 1, 2009. The credit is ten percent of the purchase price or the stated maximums, whichever is less. The credit is not available to those with upper incomes, such as above $95,000 for a single person.

Legally, this is a “refundable tax credit,” since the tax reduction has to be paid back over fifteen years. In effect, it is an interest-free loan, a subsidy for the amount of interest that would otherwise have been paid. If the house is sold within 15 years, then the remaining tax credit has to be paid back, unless there are no capital gains, in which case there is no payback. A law has been introduced in Congress to make this a pure credit, eliminating the pay back.

Superficial thinking might conclude that a tax credit for buying a house is good for the economy, since more folks will buy houses. More house buying would reduce the decline of residential real estate. That would reduce the mortgage defaults, help the banks, and the birds would sing.

More thorough thinking would realize that what one person gains, others must lose. The tax credits will reduce tax revenues in 2009 and 2010, making the federal budget deficit that much larger, and requiring more borrowing. That sucks in money that would have been invested in job-creating private enterprise.

Recessions end when real estate prices fall back to their normal ratios of prices to rentals, or below that, so that houses become affordable or even bargains. Propping up house prices delays the recovery, since it makes real estate more expensive for those who do not get the tax credit.

Tax credits complicate the income tax code, and HERA and other “stimulus” and “recovery” acts are compounding the complexity of the federal and state income taxes. Every time federal tax law is changed, state income taxes often have to be changed. This is good for the army of professional income tax helpers, but it creates a greater excess burden on the economy.

It is also unfair to give some folks a tax credit or free loan, and not to others. Moreover, such tax credits further distort the economy’s prices. A market price is a signal reflecting scarcity and desire. A higher price indicates greater demand or lower supply. When the tax code skews and distorts these price signals, it creates economic waste, as too much production of stuff that is relatively less desired and not enough of what people would rather have.

The best stimulus and recovery policy would keep it simple and minimize distortions and unequal treatments. First, to stimulate demand, just give everybody an equal amount of cash. That would let individuals decide what to buy, rather than the goods and interests favored by politicians. Second, to stimulate supply, shift taxes off of income and goods and into pollution and land value. Pollution is subsidized because folks who buy stuff don’t pay for the social cost of the pollution damage. With an income tax, folks get punished for working. With a pollution tax, they get punished for poisoning the planet. Is that so hard to understand?

Instead of subsidizing favored goods such as housing, the tax code should just let folks keep more of their own earnings, and let them decide what to buy. As it is, real estate is highly subsidized, because governmental services such as transit make locations more productive and attractive, raising rents and site values. A land-value tax takes back this subsidy, so it is in essence not so much a tax as the prevention of a subsidy.

This house buying tax credit is just another subsidy for real estate, and fundamentally it is real estate subsidy that generated the unsustainable speculative economic boom that turned into the real estate crash and economic depression. It is like a doctor giving you bad medicine that makes you sick, and to cure you, he gives you more of that poison.

So the answer is that a tax credit for house buying is bad policy. There is now some change in Washington DC, but the fundamentals of tax policy have not been changed. The tax complications that seek to stimulate real estate are like drugs that might make some people feel better today, but will hamper the health of the economy in the future, while we are still alive and have to bear the costs.

This article first appeared in the Progress Report, www.progress.org. Reprinted with permission.

Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.


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Comments

Once someone is addicted to drugs, one must be careful how the addicted substance is withdrawn.

An LVT would be dangerous medicine indeed, since it would further depress land prices and put borrowers with existing mortgages even further under water. Unless some of the proceeds of this tax go toward reducing the principal balance for mortgage holders, the cure you propose is worse than the disease.

The time for an LVT introduction is not during a bust, but the beginnings of a boom.

# posted at by Michael Bindner

Actually, the tax credit would be a good thing because...it would apply to ME!! Bwahahahahahahahaha!

(I'm buying my first house this month.)

# posted at by Carl Milsted

WHAT HAPPENS TO HELP THE ONES OF US THAT HAVE SPENT ALL THERE SAVINGS BUYING THEYRE HOUSE AND STRUGGLE MONTH TO MONTH TO HAVE THE AMERICAN DREAM. WHY SHOULD WE EVEN TRY WHEN EVERYONE ELSE GETS HELP?

# posted at by JOYCE ROBERTS

Whats with the caps? It's the american dream cause you have to be asleep to believe it. They will have worked harder and be better people for working so hard....

# posted at by Chris K

And that gets you where?

# posted at by JOYCE ROBERTS

No where, and I think thats the point.

# posted at by Chris K

Carl, sadly, you spoke too soon. It didn't apply as much as it might of.

Are you getting any sleep, or has teething started?

# posted at by Michael Bindner

Let's look at the LVT numbers again. I just got my property tax bill, which included an estimated land value of 75 thousand dollars. Let's assume for the sake of argument that this is accurate. At 84 cents per hundred dollars in value, my current LVT is about $630 per year.

Under the proposals offerred, this will not maintain for long. As a fairly average family (2 earners, 1 child), we pay around twelve thousand a year in payroll taxes, about 6 thousand in federal income taxes (if memory serves) and 2 thousand in state income taxes. We also pay roughly two thousand dollars in sales taxes a year. In other words, our current tax bill is about twenty two thousand dollars per year. As average property owners, I would expect that our total tax burden would not change - meaning if we went to a single LVT to pay all taxes, our rate would be roughly 29 dollars per hundred dollars of land value per year.

Any dreams we had of buying a few rental properties for retirement income would be gone under such a scheme. Why double our tax burden?

Land values will, of course, go down as people move to the rental market. However, since expenditure will not in the short term, rates will go up.In other words, if property value is halved, the tax rate becomes fifty eight dollars per hundred.

The political acceptability of such a rate is doubtful.

If we stay in our house, the amount of our monthly escrow contribution will go up by roughly $2000 per month, making our monthly morgage plus condo payment about $3500. We would, of course, seek rental housing and walk away from the mortgage. Quite a few people will walk away or not pay their LVT, since the cost of paying the LVT will be less than the value of the property. In the end, the commons will own it all and no one will fund government. The upkeep on rental housing will also go down, since it will be unsaleable - the only way to unload it will be to not pay the LVT for two years. Unless you bring back debtors prison, most folks will walk away.

# posted at by Michael Bindner

Just a follow up. The search for an "acceptable tax base" seems to be resistence to the income tax, given its mention in the Communist Manifesto and association with socialism.

Get over it. Every tax is eventually a tax on income (or consumption if you prefer, since one persons income comes from another's consumption), since income, broadly defined, is taking money in. Even an LVT is an income tax on a single factor, land. As the prior analysis suggests, rendering land worthless also renders improvements worthless due to the tax burden associated with buying the improvements.

The renters who seek tax avoidance will bid up the cost of rents, thus capturing what they would have paid in income tax in their rent - so all of the tax avoidance premium would be transferred to land owners who would then have the incentive to pocket the funds and walk away, leaving the deed on the table of the tax assessors office.

Once the property is owned by the state, the renters will flee like rats, since they cannot be forced to purchase their rental units. Only the rats will remain and the squatters.

Not a pretty picture if you think it through.

# posted at by Michael Bindner

An LVT, like the Fair Tax, also has no rational basis for privatizing government services. For example, there is no logical connection between diverting funds from LVT to retirement savings of the renter. It is slightly possible if everyone rents to allow land owners to designate an alternate school and mental health provider - or to allow the renters to vote on the distribution - although there is no reason why the LVT holder should allow renters the priviledge if he or she has an opinion (likely she, since most property owners are women) - having employee-owners decide on the distribution of business income taxes makes much more sense. It is much more logical to redirect revenue for social services to private sources using a business income tax than any other type of levy - assuming the business is owned by the employees (by privatizing social insurance taxes toward such ownership).

# posted at by Michael Bindner

Some criticise land value taxation because it would add a payment in addition to the mortgage. They are assuming that LVT would be implemented as stupidly as possible. That is bad reasoning. One should first assume an intelligent implementation. If there is an existing mortgage when LVT is first implemented, for that part of land value that is mortgaged, the LVT would be on the lender, not the title holder. The tax would replace the interest the bank otherwise would have gotten. If the bank is insolvent, the tax payment can be postponed.

"Quite a few people will walk away or not pay their LVT, since the cost of paying the LVT will be less than the value of the property."

If the tax is LESS than the value, why would somebody walk away? My property tax is a lot less than the value of my property, and I pay the tax.

"As the prior analysis suggests, rendering land worthless also renders improvements worthless due to the tax burden associated with buying the improvements."

What? Even if the land value tax is 100%, it does not tax the improvements at all, so why would they be worthless?

"It is much more logical to redirect revenue for social services to private sources using a business income tax than any other type of levy - assuming the business is owned by the employees (by privatizing social insurance taxes toward such ownership)." Posted by Michael Bindner.

Why is a tax with a deadweight loss better than one without a deadweight loss?


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