Federal tax policies inflate house prices for high wage earners
Home mortgage interest deduction encourages high wage earners to borrow more; capital gains tax exemption encourages wealthy to invest more in personal homes. The combined effect inflates house prices.
Politicians promote home ownership through a variety of subsidies and tax loopholes, ostensibly to promote a sense of community and quell civil unrest, the modern bread and circuses. A 2014 Republican tax reform proposal curtails homeownership subsidies, and the proposal was vigorously opposed by realtors, homebuilders, and lenders who benefit from the subsidies.
Supporters of the subsidies generally control the perception of their largess through planted stories in the financial media appealing to homeowners who rely on the subsidy to reduce their tax bills; however, those who want to reduce these subsidies occasionally gain press attention of their own, so the public is exposed to the truth about who these subsidies benefit and how much they cost.
Tax benefits that inflate house prices
There are two provisions in the tax code that strongly impact house prices: the home mortgage interest deduction and the capital gains tax exemption. Both tax loopholes make owning a family home more financially desirable by reducing tax burdens on carrying costs and disposition profits.
The home mortgage interest deduction benefits high wage earners who borrow most of the money to buy a personal residence, which most high wage earners do. This tax break doesn’t benefit the wealthy who pay cash directly, but since it makes debt cheaper for high wage earners, the tax break inflates house prices where high wage earners and the wealthy live.
The capital gains tax exclusion provides an incentive for the wealthy to invest in personal residences. Ordinarily, investing in an expensive personal home wouldn’t be a wise decision for a wealthy person because the property taxes are an expensive carrying cost (which most people ignore); however, since any gain on sale is potentially exempt from capital gains taxes up to a high threshold ($250,000 single, $500,000 married), wealthy owners gain an offset to their high carrying costs. Plus, it provides a financial justification for buying an opulent home.
The increased incentive for the wealthy to buy homes shows up in Coastal California. The housing market reports I publish show most of the beach communities as being overvalued today. Some of this overvaluation is due to the increasing wealth concentration among the 1% who buy properties in these areas, but some of the overvaluation is also caused by an increased incentive for the 1% to park money in these properties due to the capital gains tax break. My reports use the 1993 to 1999 period as a benchmark, and since the capital gains tax exclusion was passed in 1997, the impact wasn’t felt until after the benchmark was established.
The potential home ownership subsidy changes would flatten Coastal California house prices because house prices here rely on these subsidies. Reducing or eliminating the tax benefits would increase home ownership costs and thereby make home ownership much less desirable as an investment. Home ownership subsidies inflate house prices because of the investment incentive and introduce volatility to the system. Further the subsidies do little to increase home ownership rates or improve communities. Given the high cost to the government, $121 billion in 2013 for the home mortgage interest deduction alone, it’s a costly subsidy that should be eliminated or curbed.
Homeowners in the U.S. last year received a total of roughly $70 billion in federal tax breaks through the deduction. But discussions in Congress about a broad tax overhaul are heating up, and all sorts of tax deductions—including the mortgage-interest deduction—are being discussed by both parties.
Supporters of the mortgage-interest deduction say it encourages homeownership and gives the middle class a better shot at financial security. The deduction helps middle-income purchasers by making their mortgage payments more affordable and by helping these families build equity in their homes.
But critics say the deduction mainly benefits those with higher incomes. They say that it does nothing to help lower-income Americans who rent. In addition, they argue, in these tough budgetary times the government could put the forgone tax revenue to good use.
[full article explores both viewpoints]
The tax subsidy for mortgage interest does not make houses more affordable for the middle class because the value of this benefit gets priced in to the resale price of the house. Any financial market will find an equilibrium, so shortly after the tax break was put in place, house prices inflated to price in the benefit. The cost of ownership calculations available on properties on this site shows how the tax savings brings monthly costs back in line with rents. If this subsidy were eliminated, people wouldn’t be willing to borrow so much, and prices would fall to a new equilibrium.
Benefits said to help wealthier people acquire larger homes more than boost ownership
Federal tax benefits for homeowners primarily help wealthier people borrow more money to buy larger houses rather than boost homeownership, according to a new study. …
Policy makers have long supported homeownership in the tax code because it is viewed as having broad societal benefits, and they have been loath to curb the mortgage-interest deduction, which is popular with voters and strongly defended by the real-estate industry. But the new findings add to a growing body of economic research that suggests Americans don’t benefit broadly from the tax preferences, which the study estimates cost the government $175 billion annually in forgone revenue.
Most people don’t benefit, particularly those people in flyover country. Unless the debt is over $160,000, the borrower is better off with the standard deduction.
In addition to the mortgage-interest deduction, owners benefit from capital-gains avoidance when realizing a $250,000 gain from a home sale, a provision that benefits households in coastal markets with greater home-price appreciation.
Not everyone agrees that the tax code encourages purchases of larger homes. Robert Dietz, an economist at the National Association of Home Builders, said tax filings also show larger families tend to take larger deductions, and larger families need more space. …
The research also found the tax benefits for owner-occupied homes generally accrue to a minority of households. Homeowners with incomes above $100,000 were between three and four times as likely to claim the tax benefit as those earning less than $100,000.
The mortgage-interest deduction is available only to those who itemize deductions on their tax returns, and few low-income households itemize because they generally can have a lower tax bill by taking the standard deduction. …
This may ultimately prove the downfall of this tax subsidy. When the lower half realize they are subsidizing the mortgages of the upper half, it won’t sit well with them. Right now, ignorance is maintaining their support, but with more articles like this one expounding the truth, lower wager earners might demand change.
Mr. Hanson’s study examined the sharp disparities in benefits by region and income. The average annual savings for households claiming housing tax benefits are $12,300 in San Francisco and $10,700 in Los Angeles, compared with $1,600 in Detroit and $2,900 in Dallas, the study found.
Meantime, residents in San Francisco who earn more than $100,000 save $8,000 annually from the mortgage-interest deduction, compared with savings of $3,700 for residents who earn less than $100,000. In Detroit, higher earners save more than $4,000, while those earning less than $100,000 save $1,600.
The study also found that suburban residents were twice as likely to benefit from the tax code as those in urban areas.
There is no justification for maintaining the home mortgage interest deduction in its current form. It’s merely a tax break for high wage earners who don’t need it, and they take this money, bid up house prices, and give most of it to a bank. The banks are the ones most interested in keeping the deduction alive because nearly all of it makes it way into their coffers.