“Playing the Housing Blame Game” by David Leonhardt is an interesting New York Times story on what happens when you use tax policy to encourage people to spend a lot of money on houses instead of investing it in businesses. It turns out that you end up with a country with spectacularly expensive houses and feeble job growth.
Our government seems so plodding and ineffective most of the time that it is tough to remember how powerful it is.
Just imagine what the US could be if the government were efficient.
The writer omitted some facts about the tax codes that allow
the gain of up to $500,000 in tax free sales of one’s current residence.
In particular, a person has to live in said home for at least two years before they can sell.
That’s hardly a “flip”.
Blaming the real estate bubble on the tax code is a stretch. I wonder about the itemization statistic and its correlation with the sub-prime scandal. Is an effect of the scandal a large population of homeowners who don’t pay taxes because they don’t earn enough money? This would certainly explain the why they don’t itemize. I think we have to be careful when we look for solutions to problems brought on by greed and bad behavior. Let’s start with punishing the scoundrels who wrote these mortgages, then packaged them into bonds and rated them A+.
To Paul S.:
I don’t think it is a stretch at all. I’m sure that a lot of the people who were speculating on real estate were getting advice from accountants and tax lawyers.
Paul, it’s not a stretch. Philip has posted extensively about these type of things. Essentially, the government is subsidizing the most low-tech, nontradeable, nonstrategic elements of the economy (i.e., buidling houses out of sticks like my great-grandfather did, but with inferior materials) , while simultaneously saying that engineering is “jobs Americans won’t do” or is “overpriced so we need to bring in millions from the third world.”
Furthermore, the FIRE (finance, insurance, and real estate) portion of the economy has many elements of a Ponzi scheme. But participants in classic Ponzi schemes do not lose more cash than they put in, and the schemes are usually cash-based, rather than manipulating the market for something as essential as shelter (and the dollar amounts involved are several multiples of people’s annual incomes). FYI, median household income in the US is about $48k.
It’s a complicated situation, but ends up being a massively poor strategy. I mean, we can debate whether parents should give money to children for getting good grades. But what the government is doing is like giving money to children when they skip school to smoke pot.
And back to the median income issue, I’m hardly a socialist, and have no desire to penalize successful people who create something of value. But comparing the people whose foolish overspending in real estate was rewarded simply because they were lucky enough to buy before the bubble (many people were simply too young to participate) to those who actually work for a living is instructive. Joe Engineer goes to college and gets a $60k job. After taxes in California, he’s left with $41k. Sam Speculator isn’t very bright, but he’s greedy and willing to lie and cheat, so he gets a job as a mortgage broker. Sam is a little older, so he takes on a $500k mortgage on a dump, getting a deduction for the interest. Four years later, the dump is now appraised at $900k. Sam got the equivalent of 10 years of Joe’s after-tax earnings. Joe works hard but feels poor.
And the numbers I gave aren’t that far off. Google for “real homes of genius” for examples of houses that skyrocketed for no reason…they sometimes also list the median income in the zip code, so you can see that the houses were clearly unaffordable and unrelated to the fundamentals that any reasonable person would examine.
Some of us just want a decent house at a reasonable price. I think that is clearly in the public interest (and we have several agencies like HUD and FHA that are presumably designed to support this).
K,
Entrepreneurs and engineers don’t always make the same amount of money, nor should they.
It seems as if poor Sam is being savaged for being an entrepreneur while Joe is being lauded for being an engineer. It’s a comparison of an apple and an orange…or maybe a sour grape (no pun intended) since dumb Sam made ten times what smart Joe did.
Or do you simply want government control of real estate prices? 🙂
Rglovejoy,
The two year capital gains requirement, the once in a lifetime rule and the uncertainty of the RE market all would make a house a poor place to speculate with your money if it was not your business. My financial advisor has routinely told me that if I were to come to him saying I was going to build houses or start a restaurant he would disown me.
K,
You cover many different ideas in your post, I’ll stick with the tax code being responsible for the bubble aspect. I thought the line about 50% of mortgage holders did not itemize was in Phil’s post, anyway it is in the article. You mention the median income is $48k meaning that half of income earners fall below this line. If you dig hard enough you will find that half of income earners (those above $48K) pay 96% of Fed. income taxes. Most of those at or below the median or even above it to a certain point have no need to itemize, because they pay little or no tax. Now if the sub-prime scandal generated large numbers of unqualified mortgagee’s who didn’t need to itemize because they already were paying no tax, I would say that is an effect not a cause of the problem. I also point out that the mortgage deduction has been around for a long time, low interest rates and lax large scale criminal underwriting have not.
As far as the engineer versus the mortgage broker, in my humble opinion the engineer should win that income showdown every time. It amazes me how engineers, who make difficult decisions for a living, feel inferior and defer to business majors, most of whom would not be able to think their way out of a paper bag. Part of the problem is the engineer’s education. I think all engineers should be required to take a general business course as part of their bachelor degree. The course would introduce the student to basic business accounting, writing a business plan, reading a prospectus and understanding a P and L statement. I think a course like this would be a boon to the economy.
Guys: Homeowners who don’t itemize probably don’t itemize because their mortgage interest is less than the standard deduction ($10,700 for a married couple in 2007, according to Wikipedia). To the extent that mortgage interest is not much more than the standard deduction, a homeowner will not benefit much from this part of the tax code. The NY Times writer was just pointing out that preserving the mortgage interest deduction only helps those who borrow money to buy expensive houses. It doesn’t help people who pay a small mortgage on a standard house in the Midwest.
Todd,
“Sam” was not an entrepreneur, he was a low-skilled employee who bought a personal house (not an income-producing property) he could not reasonably afford. The government treated his over-consumption more favorably for tax purposes than the engineer’s productive work.
I have an engineering degree and have also been an entrepreneur. Entrepreneurs take on *RISK OF LOSS*. Except in this case, the government has privatized the profits and socialized the losses of a particular industry.
I most emphatically do *NOT* want the government to set housing prices. That is what I OPPOSE. This repeat of Tulip Bulb Mania was accelerated by the government’s policies (monetary expansion, Fannie Mae / Freddie Mac / Ginnie Mae, lack of border enforcement, etc.) had a very significant role in creating this bubble. And now the government is using MY TAX DOLLARS and risking THE GOVERNMENT’S VERY SOLVENCY (i.e., by taking on liability for Bear Sterns’ bad loans) to keep housing prices at unrealistic levels. And if the government does meddle in markets, it should do so in ways that are for the public good, like AFFORDABLE housing.