Housing: Time to Halt Taxpayer Subsidies

Farrell neglects some important aspects of government's encouragement of home ownership. By encouraging citizens to invest in housing the government ensures that the citizen has a stake in the success of the system. As the article mentions owning a house is part of the American Dream. It may have become a nightmare for some now but probably many of those who have lost will just pick up the pieces and shoulder on hoping to eventually own another house. At most the clamor will be for bailouts not just of the financiers who floated the sub-market prime issues but to some degree for those who are losing their homes.
Farrell makes the interesting point that the rich rather than the less well off profit most from mortgage payment tax breaks but that is hardly surprising since free market capitalism is basically designed to best serve those with the most money. In fact a market rations goods on the basis of cash people hold or can borrow.
Anyway in a capitalist democracy votes also need to be bought and that often involves providing at least some aspects of the American dream, even if the techniques of doing so do not make sense to every business commentator.

Commentary April 17, 2008, 12:01AM EST
Housing: Time to Halt Taxpayer Subsidies

Even with the housing market declining, it's bad policy to give homes
preferential tax treatment over stocks and other investments

by Chris Farrell

Homeownership has long been a vibrant part of achieving the American
Dream. But these days owning a home is more like starring in a horror
flick, perhaps called Nightmare on Main Street. The numbers are
frightening. Home prices are falling nationwide, and the foreclosure
rate is at record levels. The delinquency rate for subprime adjustable
rate mortgages is an astonishing 20%, and the Federal Reserve's home
equity measure is at its lowest level in 60 years. Indeed, Moody's
Economy.com estimates that more than 10% of the nation's homeowners
were "upside down" on their mortgages by the end of March. In other
words, the value of their mortgage is greater than what their home is
worth.

It's a safe bet with both the housing market and the economy
deteriorating that more federal money (as well as state funds) will go
toward supporting housing this year. But once the downward trajectory
moderates, the government should learn from recent experience and take
a radical stance: Forget propping up housing. Instead, eliminate
taxpayer subsidies for housing. Yes, you read that right.

The Bubble: No Coincidence

There's no question the U.S. tax code is full of special tax
provisions that favor housing. Among the biggest breaks are the
mortgage interest deduction, the deduction for state and local real
estate taxes, and the capital gains exclusion for homes. (The first
$250,000 in profit is exempted from capital gains taxes for individual
filers, and $500,000 profit for couples.) The federal tax code funnels
more than $100 billion annually into the housing sector, estimates the
Tax Foundation in Washington D.C.

This figure doesn't include the mammoth subsidized institutions that
support the housing and mortgage markets. This includes Government
Sponsored Enterprises like Fannie Mae (FNM) and Freddie Mac (FRE) , to
name only two of the best known players. The Congressional Budget
Office estimated that in 2003 the benefit of the explicit and implicit
ties to the federal government for GSE such as Fannie Mae and Freddie
Mac amounted to a federal subsidy of more than $23 billion, according
to economists William G. Gale, Jonathan Gruber, and Seth
Stephens-Davidowitz in their 2007 paper, Encouraging Homeownership
Through the Tax Code.

Yet in a modern, dynamic high-tech economy, why should homes get
preferable tax treatment over stocks and other investments? The tax
gap in treatment is significant. Take capital gains. Say you'd
invested in a basket of high-tech stocks three years ago and now you
sell the portfolio for a $500,000 profit. Well, you'll pay a 15%
capital gains tax rate on the gain, writing a $75,000 check to Uncle
Sam. But you and your husband also sell the home you bought three
years ago for a $500,000 profit. Guess what? The Internal Revenue
Service gets nothing.

By the way, the tax break for capital gains on housing was signed into
law in 1997. Is it a coincidence that home prices soared 79% in the
time between the first quarter of 1997 and the first quarter of 2005,
with home prices not just going up but rising at an increasingly rapid
rate, as calculated by Peter Bernstein, a long-time advisor to
institutional investors and author of Against the Gods: The Remarkable

Story of Risk. It's doubtful.

Lessons of the Past Decade

What's more, the mortgage interest deduction is simply bad tax policy.
It's sold as a middle-class subsidy, but since the value of the
deduction goes up with the size of the mortgage, the biggest break is
enjoyed by the highest-income households. For instance, the
President's 2005 Advisory Panel on Federal Tax Reform calculated that
individuals making more than $200,000 a year received more than eight
times the benefit of those earning between $50,000 and $75,000 a year.

These days, no one can doubt that a home is an investment. It's an
asset class, like stocks and bonds. Indeed, one reason why housing
prices hit such stratospheric heights was the potent combination of
owners treating homes as an investment, and the capital markets
shoveling huge sums of money into real estate through such innovations
as collateralized debt obligations (CDOs). For awhile, the net effect
was to increase the liquidity of real estate "investments," supporting
an unprecedented degree of speculation.

The tax code shouldn't bias investment money to favor one kind of
investment over another—certainly not in an intensely competitive
global economy. Let the economic fundamentals dictate where investors
place their financial bets on the future rather than the tax-writing
prejudices (and campaign contribution solicitations) of Congress and
the White House.

The History of Subsidies

To be sure, calling for the end of housing subsidies is at best
reminiscent of tilting at windmills. After all, governments have long
favored housing. The world's first subsidy for single-family homes may
have been under Constantine I in the capital city of Constantinople,
speculates David Smith, founder and head of the Affordable Housing
Institute in Boston. The subsidy was a perpetual grant of a ration of
bread—the panes aedium. It was given to anyone that built a home in
the city, and the panes aedium was passed along to the new homeowners
at sale. "Strikingly, the panes aedium was not just a first-time home
buyer incentive, but an ongoing property asset, in much the same way
as real estate tax abatements or exemptions are intrinsic property
rights in the modern," writes Smith.

That said, the lesson of the past decade is that too much investment
money goes to real estate in modern America. At a time when companies
from China, India, South Korea, Brazil and other emerging markets are
competing with American firms for markets and profits, it's time to
stop the madness.

Farrell is contributing economics editor for BusinessWeek. You can
also hear him on American Public Media's nationally syndicated finance
program, Marketplace Money, as well as on public radio's business
program Marketplace. His Sound Money column appears on
BusinessWeek.com.
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