Potential home ownership subsidy changes would flatten Coastal California house prices
Most proposed changes in government housing subsidies remove incentives for high wage earners to take on excessive debts to inflate house prices. Coastal California would be strongly impacted by any changes to the current tax regime.
Congress considers changes in the mortgage subsidies in the United States. Most realize the current regime doesn’t boost home ownership rates, but it does inflate house prices and exacerbate home price volatility, mostly through encouraging excessive debt — and these subsidies are very expensive. The question is what should we replace the current incentives with? My preference is for total elimination. When a costly subsidy achieves none of the goals legislators desire, why keep the subsidy at all? The subsidies remain because those that benefit from them fight to preserve them; however, at some point, the enormous cost starts to impinge on other budget items, and legislators look for places to increase revenue to fund other pet projects; thus home ownership subsidies are on the chopping block.
Ben Harris — Posted on January 6, 2014, 10:03 am
Tax expenditures for homeownership, such as deductions for mortgage interest and property taxes and the partial exclusion for capital gains on the sale of a primary residence, have long been recognized as ineffective, regressive, and extraordinarily expensive—costing $121 billion in 2013 alone. Until now, most reforms—including the Bowles-Simpson deficit-reduction plan—have focused on restructuring the mortgage deduction into a flat-rate credit. But what if we largely replaced the deduction with incentives to buy a house, rather than to run up a lot of mortgage debt?
In a new Tax Policy Center paper, my TPC colleagues Gene Steuerle, Amanda Eng, and I examine three very different tax subsidies for housing. Instead of encouraging people to borrow, they would create incentives for homeownership without tying tax breaks to mortgage debt. Each would be financed by eliminating the deduction for property taxes paid and capping the mortgage interest deduction at 15 percent. Thus, none would add to the deficit over 10 years. Here, briefly, are the three options:
- A permanent First-Time Homebuyers Tax Credit, similar to the provision temporarily in effect during the Great Recession. The credit—$12,000 for singles and $18,000 for married couples—would give new homeowners a one-time lump sum subsidy in the year they purchased a home. The credit would be refundable, allowing households with low income tax burdens to claim the full value of the credit.
We saw how poorly that worked the first time, why would we repeat that mistake? My observation was the buyers overpaid by $30,000 to $50,000 to gain an $18,000 credit. If we make this permanent, we merely inflate the price of entry level homes by $30,000 to $50,000 across the nation. Perhaps this will prompt homebuilders to favor entry-level homes over McMansions, which wouldn’t be a bad thing, but why do we need entry-level houses to be higher priced? Doesn’t that defeat the purpose?
- A flat annual subsidy for homeowners. Taxpayers could claim the credit—$870 for singles and $1,300 for couples—in any year in which they owned their home. The credit would be refundable and would phase out for upper-income households.
This really illustrates the absurdity of housing subsidies. Why in the hell would you force renters to give money to homeowners? That would sow the seeds of a tax revolt in my opinion.
- An annual 36 percent flat-rate credit for property taxes paid, up to a maximum of $1,400 for single filers and $2,100 for couples. Like the other alternatives, the credit would be refundable.
Each would offer homeownership subsidies to a wide range of taxpayers, rather than concentrating the benefit on those with high-incomes who itemize deductions. All three would raise after-tax incomes for the bottom 80 percent of taxpayers while trimming after-tax income for the top 20 percent. And each would raise housing values by about 1 percent by lowering the after-tax cost of housing investment.
In other words, all three proposals hurt Coastal California.
They also are more in line with economic arguments for subsidizing homeownership. Economists justify these tax subsidies on two grounds: 1) homeowners have a financial investment in their neighborhoods and therefore work to maintain them and 2) homes contribute to asset accumulation, and therefore to higher saving that provides greater security when incomes fall, such as when people lose jobs or retire. In contrast to current preferences, which are worth more to those with higher mortgage debt and in higher tax brackets, these alternatives tie the value of the subsidy more directly to homeownership.
Admittedly, all three of the proposals above are better than our current system.
None are perfect. For example, the First-Time Homeownership Tax Credit does not reward long-tenured homeowners, the annual tax credit does not reward upper-income homeowners, and the property tax credit would probably cause local property tax rates to rise.
The social value to homeownership may or may not be worth more than $100 billion-a-year in government subsidies.
But regardless, if the goal really is to encourage people to buy homes, any of these alternatives would be superior to the current deductions for mortgage interest and property taxes.
After reviewing the alternatives, do you see the folly in housing subsidies? Each proposal diverts money to one segment of the market over another and merely creates artificial price distortions. Eventually, the market finds a new equilibrium, and life goes on. The worst proposals are the ones designed to increase affordability because they accomplish the opposite.
The subsidy nobody talks about
The housing subsidy most responsible for inflated house prices in Coastal California’s move-up markets is the exclusion on capital gains for a primary residence. Individuals can exclude up to $250,000 in profit from the sale of a main home (or $500,000 for a married couple) as long as you have owned the home and lived in the home for a minimum of two years. What’s the reason for this tax break? If the idea is to avoid taxing long-term owners on normal inflation, the intent doesn’t match the rule. It would be far better to index the cost basis to CPI.
The current subsidy forces people to buy homes and climb the property ladder. For example, let’s say you bought a $500,000 home in January of 2012. That house is likely worth $650,000 today. The owner could sell and put 100% of the proceeds toward buying a new house. That’s a huge advantage to homeowners. A renter would have to save nearly $10,000 a month to get the same buying power because the $240,000 would get knocked down to $150,000 after income taxes. The gain on the home required no additional savings, and since the gain is untaxed, the owner gains a significant advantage over even the thriftiest renter.
Further, this subsidy encourages relatively short-term home ownership here in Coastal California. A modest house might go up more than $500,000 in value in just 10 years, even faster during a bubble rally. Once a family home goes up in value more than $500,000, the family may be better off selling and taking the untaxed profits to make a move up. If they wait, they must pay capital gains on the overage. Of course, there are property tax implications to that move-up, but city government’s want the churn to in order to increase their tax base and revenues.
If people had to pay capital gains on the increase in value with no exclusions, the IRS would bring in much more money, and house prices in desirable communities wouldn’t be so inflated. Of course, that too would flatten Coastal California house prices. With our current policy-driven housing market, changes in these subsidies could have a big impact here.
5 STELLAR Isle Ladera Ranch, CA 92694
$1,695,000 …….. Asking Price
$1,800,000 ………. Purchase Price
1/21/2007 ………. Purchase Date
($105,000) ………. Gross Gain (Loss)
($135,600) ………… Commissions and Costs at 8%
($240,600) ………. Net Gain (Loss)
-5.8% ………. Gross Percent Change
-13.4% ………. Net Percent Change
-0.9% ………… Annual Appreciation
Cost of Home Ownership
$1,695,000 …….. Asking Price
$339,000 ………… 20% Down Conventional
5.04% …………. Mortgage Interest Rate
30 ……………… Number of Years
$1,356,000 …….. Mortgage
$369,082 ………. Income Requirement
$7,312 ………… Monthly Mortgage Payment
$1,469 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$353 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$400 ………… Homeowners Association Fees
$9,535 ………. Monthly Cash Outlays
($2,003) ………. Tax Savings
($1,617) ………. Principal Amortization
$667 ………….. Opportunity Cost of Down Payment
$232 ………….. Maintenance and Replacement Reserves
$6,813 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$18,450 ………… Furnishing and Move-In Costs at 1% + $1,500
$18,450 ………… Closing Costs at 1% + $1,500
$13,560 ………… Interest Points at 1%
$339,000 ………… Down Payment
$389,460 ………. Total Cash Costs
$104,400 ………. Emergency Cash Reserves
$493,860 ………. Total Savings Needed