House bias: The economic consequences of subsidizing homeownership

Federal Reserve Bank of Richmond ^ | Fall 2008 | Stephen Slivinski

[curiosity]

Ask most people in America today whether buying a home is better than renting one, and you’ll likely get a response that equates renting with stuffing money down a garbage disposal. The idea of homeownership today is not one that simply evokes the comfort or pride of living in a place of one’s own. Instead, it’s become part of a common investment philosophy.

But if you ask Edmund Phelps, the Nobel Prize-winning economist from Columbia University, he’ll proudly declare that he doesn’t own a home. And to him, that’s not a bad thing. “It used to be that the business of America was business,” said Phelps in August 2008 to Bloomberg News. “Now the business of America is homeownership.” In fact, many economists will tell you that the American love affair with homeownership has some consequences that you won’t normally hear discussed.

[curiosity]

If you advocate creating a nation consisting largely of landless renters, and want to increase taxes to do it

No, all I favor is a tax code does not favor one type of residence over another. Like all fiscal conservatives, I believe people should make their decision on whether to rent to own based on economics, not on which type of residence is more tax friendly to them.

I personally think only property owners should be allowed to vote,

LOL. Good luck with that. Too bad for you it's not the 18th century any more.

especially regarding bond issues that increase property tax assessments.

Sigh. As I have to point out for the 100th time, landlords pass on property tax hikes to their tenants by increasing their rents, so renters have the same incentives to vote against property tax hikes as owners.

Perhaps many renters don't realize this since they are taxed only indirectly. There's an easy remedy: local governments can make property tax like the sales tax and have landlords list it a seperate line item on the rental bill.

[curiosity]

To the extent that the total tax take from the citizens to Organized Government should be reduced, I agree with you. In other words, if Organized Government gives up other taxes seized, I would agree the mortgage deduction might be scrapped.But I'm not in favor of unilateral disarmament.

Yes, we're in agreement. Any deductions that are eliminated need to be combined with reductions in marginal rates. Otherwise, no sale.

[abb]

One other thought. Yes, the mortgage interest deduction skews financial behavior toward an outcome that otherwise would not occur. But then, the entire tax code does that. There are many other deductions, credits, etc that should be scrapped before even talking about the MID.

Personally, I think if employers no longer served as IRS collection agents and individuals wrote the check, all other tax issues would fade into the background. There would be a tax revolt of staggering magnitude.

It would be glorious.

[abb]

I see you are an economics professor. Good. Here’s a paper written ten years ago that tells you all you need to know about withholding.

http://www.cato.org/pubs/journal/cj14n3-1.html
EVOLUTION OF FEDERAL INCOME TAX WITHHOLDING: THE MACHINERY OF INSTITUTIONAL CHANGE

Charlotte Twight

[curiosity]

Yes, the mortgage interest deduction skews financial behavior toward an outcome that otherwise would not occur. But then, the entire tax code does that. There are many other deductions, credits, etc that should be scrapped before even talking about the MID.

I agree that there are many other credits and deductions that should be scrapped, but I don't think that any of these others has nearly as big an adverse impact as the mortgage interest deduction. All the others dwarf the MID both in terms of overall magnitude as well as in terms of the number of people who take it.

[curiosity]

Interesting. Thanks for the link. I will read it.

[expatpat]

You are very wrong. Read the section “Downsides of Home Ownership” on p 14.

[curiosity]

You are very wrong. Read the section “Downsides of Home Ownership” on p 14.

I did. It does not make the argument you say they are making. From your previous post:

They claim that we are over-invested in housing because of high home-ownership vs renting

You got the conclusion right: we are indeed overinvesting in housing. You got the argument wrong: it is not because of high home-ownership rates relative to renting.

Since you seem incapable of reading the article for yourself, let me lay it out for you. The author argues that the reason we overinvest in housing is because the tax code gives preferential treatment to investment in owner occupied housing relative to other types of investment. Because of this tax distortion, people have an incentive to buy bigger houses with more bells and whistles than they would otherwise buy. Investing more in housing, in turn, means less investment in other capital goods.

[abb]

Because of this tax distortion, people have an incentive to buy bigger houses with more bells and whistles than they would otherwise buy.

Partially true, I would argue. Large, flashy houses have throughout history been built to impress others or as a sign of prosperity. Successful businessmen (Vanderbilt, Morgan, Rockefeller) did this before there was an interest deduction or even an income tax. No doubt many people tried to imitate that behavior - to "keep up with the Joneses." Cars are the same way. People want to show off.

I call it the SWIG factor. See What I Got.

[curiosity]

Oh, and another thing: the average investment required to build a unit of rental housing is smaller than that required to buy a unit of owner-occupied housing. So even if the effect of the tax deduduction were merely to shift people into owner-occupied housing, it would still cause overinvestment in housing.

However, as I noted before, the tax deduction also gives people who are going to buy anyway an incentive to buy more house than they otherwise would, and as noted in the article, this second effect turns out to be much stronger.

[curiosity]

No doubt. Some people would undoubtedly continue to buy extravagant houses even without the MID. My only point is that the MID increases the frequency with which this happens, other things being equal.

[rb22982]

You can deduct mortgage interest from rental income to get how much you actually earned.

[curiosity]

You can deduct mortgage interest from rental income to get how much you actually earned.

Well, sure. In the landlord's case, interest is a business expense that's netted out against rental business income . The landlord can't deducted it from his personal income taxes, the way an owner-occupied resident.

[rb22982]

It’s a deduction no matter how you slice it. Personally, I’d do away with deductions & go to a flat rate period. My tax sheet would consist of 1 page. It would be very simple. All income under $100,000 is taxed at 10%, all income over 100k is taxed at maybe 15%. Shrink government till it can manage with that amount of revenue.

[curiosity]

So how would you structure business taxes? Surely you would only tax businesses on their net income, and not on their revenue.

A business tax and a personal tax are very different animals.

[rb22982]

Interest on debt has no business being deducted — It would be the equivilent of me being able to deduct interest on my credit card interest. It encourages companies to keep debt to keep expanding which is (debt) the main problem of the current financial crises-unsupportable & neverending debt. With business it should be a net income - expenses but debt should not be included. It’s the exact same idea as the interest deduction for a homeowner. People that own their home/equipment/factory/car/education (no student loans) etc are punished for being prudent.

[GregoryFul]

since they do not pay taxes on the money they save in rent, which is a form of income ignored by the IRS.

A cockeyed leftist theory. Why, anyone who has a bank account, bonds, CDs or securities ought to pay the IRS tax due on interest they would have to pay to "own" those assets; anyone who owns a car should pay the IRS tax due on the fair rental value of "their" car - why not extend that theory to every piece of property that a person can "own", after all the government really owns everything, right?

[curiosity]

Interest on debt has no business being deducted — It would be the equivilent of me being able to deduct interest on my credit card interest.

Actually, the two are very different. You are not using your credit card debt to invest in income-generating capital, unlike, say, a butcher who takes a term loan from the bank to buy a meat processer.

It encourages companies to keep debt to keep expanding which is (debt)

So long as the holders of the debt have to pay taxes on their interest income, there is no distortion in allowing businesses to deduct interest expense. If you want to eliminate deductibility of interest expense, then eliminate the taxability of interest income.

Of course, the ballgame changes a bit when you are talking about C corporations, whose equity holders are double-taxed on their income, first by the corporate income tax (after interest is deducted) and second by the dividend and captial gains tax. This double taxation does indeed give favorable tax treatment to debt financing over equity financing, hence the importance of the interest tax shield in corporate finance that I teach my students about.

But this problem doesn't affect S corporations, partnerships, and sole-proprietorships, which account for the vast majority of landlords.

Furthermore, the bias toward debt financing in C corporations isn't driven by the tax deductibility of debt, but rather, the double-taxation of corporate net income.

the main problem of the current financial crises-unsupportable & neverending debt.

The problem is at the personal level, not so much the corporate level.

[rb22982]

The two are not different--It rewards people to extend financially and punishes those that have no debt. Even if you don't consider a credit card debt deductible there is little difference in debt for business and a consumer using a car/home/education loan (personal investment). Say whatever you want, but in my opinion INTEREST on DEBT has no business being deducted by consumers or businesses. Of course the banks love having it be able to be deducted as it encourages people to take debt.

Businesses are extremely overleveraged at the moment. "Major" bankruptcies ($50 million or more) are soaring. There was a 42% increase in corp bankruptcies last year and most expect this year to be a lot worse. We're just now starting to see the CRE debt implode.