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.