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Economics, Industry NewsThe politics and economics of the homebuyer tax credit
The Facts
In 2008, Congress passed (and then-President Bush signed into law) a $7,500 tax credit “to provide an incentive for first-time homebuyers” purchasing a home on or after April 9, 2008 until July 1, 2009. Then, as part of the American Recovery and Reinvestment Act of 2009 (which President Obama also signed into law), Congress passed the 2009 First-Time Home Buyer Tax Credit. This bill established an $8,000 tax credit for all virtually all first-time purchasers of real property between January 1, 2009 and December 1, 2009.Â
As the end of 2009 approached, it was clear that many buyers would not be able to make the December 2009 date so the Home Buyer Assistance and Improvement Act extended the closing deadline to April 30, 2010. (A $6,500 Repeat Home Buyer Tax Credit was also added for other buyers.)Â Very recently, Congress passed the Home Buyer Tax Credit Extension, which enables buyers with pending contracts as of April 30, 2010 to qualify for the credit through September 30, 2010. President Obama signed the bill earlier this month.
It has been estimated that as many as 200,000 buyers would miss the credit without the current extension. It has also been widely reported that some 1,300 prison inmates claimed the credit (costing $9 million) from jail! Despite the fraudulent claims, it is clear that the home buyer tax credit programs are enormously popular. So, let’s look at the politics and the economics of this policy.
The Politics
Led by the National Association of REALTORS® and the National Association of Home Builders, the effort to claim federal support for their industries has been very well received throughout the country. There are many justifications provided for the legislation: to stimulate the US housing market, to assist housing markets in difficult times, to stabilize battered housing markets and take advantage of low-interest rates. But none of these are really needed: in an era of dramatic government spending in trying to stimulate a recession-weary economy, any of these reasons appear to be sufficient. Perhaps the best reason is that housing retains its place as a cornerstone of the American Dream; assistance to enable market participation is almost viewed as an American right of citizenship.
Some have advocated making the tax credits permanent. The reasoning is that additional assistance is needed, especially for first-time buyers who lack capital and experience. The state provides assistance, including subsidies in many other areas such as mortgage financing, so why not induce individuals into home buying?
Put aside the fact that we have just come through a painful period when encouragement of home ownership for many without sufficient income or creditworthiness has not worked out so well. The politics of home buying tax credits are clear: households purchasing housing like the credit and the industry views the policy as supporting house prices. The credits accelerate the number of offers to purchase to take advantage of the credit. Thus, tax credits are very popular.
The Economics
It is virtually certain that tax credits have no long-term impact on the market, however, the objective is to support the housing market and real estate industry in the short-term. Endorsing a short-term subsidy is one thing; observing a lasting effect is quite another.
The recent experience of these housing tax credits has become clear in recent weeks. It is widely acknowledged that as much as one-half of all real estate transactions since 2009 have been associated with the first-time tax credit. This is good during a period of significantly fewer transactions. The problem is that some buyers are already over-extended. More importantly, in what appears to be a market recovery, now with expiration of the credits, normalcy in the market seems to be an illusion,
Existing home sales fell 2 percent in May 2010 but were stronger than they would have been without the credits. But new home sales plunged 33 percent in May to the lowest sales level since 1963 when the Commerce Department began to keep track (CNNMoney.com, June 23, 2010). “We fear that the appetite to buy a home has disappeared alongside the tax credit,” said Paul Dales, an economist with Capital Economics (YAHOO! Finance, June 23, 2010). “We all knew there would be a housing hangover from the expiration of the tax credit. But this decline takes your breath away,” noted Mike Larsen of Weiss Research (YAHOO! Finance, June 23, 2010).
NAR’s pending home sales index fell 30 percent as well. “Sales fell off a cliff after the tax credit expired. It’s the biggest monthly decline ever and the index is at its lowest level since NAR began tracking it in 2001,” concluded Larsen (CNNMoney.com, July 1, 2010).
Conclusion
Getting a direct inflow of government cash feels good if one qualifies or if one’s business is directly affected. Given the pervasiveness of support for homeownership, even now, it is not surprising that tax credits of this type are popular. This does not mean they are effective. Over and over again in a wide range of markets (remember “cash for clunkers”), people respond to incentives by accelerating their purchases during the subsidy period. What happens afterward is also clear: sales fell off a cliff.Â
The next few months are particularly risky but the tax credit story has been told.
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Austin Jaffe, Ph.D. is PAR's Consulting Economist from the Smeal College of Business at Penn State University. |
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Dear Dr. Jaffe:
I agree with your overall belief in the “beauty of the market system” and think that the economy as a whole, and the housing industry in particular, would be much better off with a “hands off” approach by government and taxing authorities.
Although I have no supporting evidence, I believe that once the government intervenes, purchasers tend to wait, expecting another incentive plan of some type. They ask temselves, “Why should I buy today when I might get a better deal tomorrow?”
The normal demand of housing should still be in place (young adults getting married and setting up housekeeping, older owners downsizing or moving to retirement areas, etc) Yet the noted decline in house sales immediately after the expiration of the tax credit, to me, indicates some type of “wait-and-see”. Maybe they are renting while saving enough money for a down payment or maybe they are waiting for prices to improve before they sell to downsize, but maybe, just maybe, they are waiting for another handout from the government.
Richard,
Thanks for your comments. However, there seems to be a fundamental philosophical difference between our views. Your prescriptions are prime examples of “artificial market clearing mechanisms.” In market systems, there is a very efficient mechanism already in place. If supply is expanded due to foreclosures, the price is expected to fall; tax credits are not needed to bring the market back to equilibrium. Of course, tax credits bring back an artifical equilibrium at higher prices and some parties like that. Similarly, modifying mortgages for the purpose of slowing the supply on the market produces other bad effects (e.g., moral hazard: it rewards bad behavior on the part of borrowers).
The beauty of the market system is that equilibrium forces produce changing prices over time. Movements in prices are evidence of changing sentiments which tell us much about what people think is going on in the market. This information solves many problems and is one of the subtle and magical characteristics in market economies. Also, it has always been a mystery to those who like to tinker with market behavior through intervention, especially if it sounds good to them.
Austin
Artificial market clearing mechanisms don’t work for long, but the tax credit was needed to juice demand as a counterweight to the supply side imbalance caused by the pace of foreclosures. Better now to concentrate on mortgage modification to slow supply and let the traditional rent/buy equation bring the market back in balance.
Austin Jaffe has a gift for articulating the reality of economic situations. He is a pleasure to read and to listen to. I wish our government officials had even half of his brain power. I absolutely agree with his assessment, but that is meant as a humble statement since I am not an economist — I just have common sense.
By the way, I have heard but can’t confirm that the prisoners used the SAME house in their scam. Just makes you wondering who is doing the checking on these things — if anyone.