Mark Thoma points to Thomas Palley playing lightning rod with “Tax Policy and the House Price Bubble.” With a title like that, you might expect a prima facie case for a causal link between tax preferences for homeownership and the bubble, but Palley’s lede is deeply buried and there turns out not to be a lot of there there. The central issue is that there’s no obvious variation in tax policy that is associated with the bubble. More after the jump.
Plenty of Sensible Economists have sniped at the mortgage interest deduction among other favorable tax treatments for homeownership. Reforming, though not eliminating, the mortgage interest deduction also was a recommendation of the Tax Reform Panel whose report was broadly ignored after its 2005 publication gave some of us in the econoblogiverse plenty of material (for anyone interested, my contemporary blogging on the subject is linked here). Palley recites the traditional indictment: the tax policies are expensive (*), pay the middle- to upper-middle classes to do something they’d do anyway (**), are unfair to low-income taxpayers who don’t itemize or otherwise get a smaller deduction (***), and by increasing house prices work somewhat at cross purposes to the notional intent of making housing more affordable. Fair enough.
Thing is, as far as the housing bubble is concerned, none of this is new. The deduction was distorting the housing market well into pre-bubble history. Indeed, the reductions in marginal tax rates affecting most middle- and upper-income taxpayers ought, in principle, to have reduced the distortion on the margin. Here, for instance, is the CPI-adjusted OFHEO house price index against the marginal tax rate applicable to a family with a constant-dollar income somewhat north of mine (****):
Correlation is not causality, of course, but the simple correlation here is negative (-0.55). Moreover, there isn’t any clear connection between the major changes in tax policy over the period and bubbly prices, unless someone can account for the rather variable lag structures. The 1986 tax reform eliminated the deductibility of non-mortgage interest, which in particular made home-equity credit relatively attractive; in 1997, the capital-gains treatment for owner-occupied housing changed. In both cases, at least using the CPI adjustment, prices had started recovering from their local troughs before enactment of the changes.
The ’97 change — which replaced a tax deferral for homeownership capital gains rolled into another residence with a flat exemption of $250,000 for an individual (twice that for joint filers) — is tricky. It does favor owner-occupied housing as an asset class by making something of a Roth IRA out of one’s house. However, the benefits relative to previous law only assert themselves upon exit of the owner-occupied housing market, and the complete tax deferral of rolled-over equity may have been worth more in the short run to movers up or down in areas with high nominal appreciation. Also, this was enacted against the backdrop of a right-of-center program to reduce taxation of capital income; I tend to the view that there’s not a lot of distortion between a zero capital gains tax rate and the low rates that currently prevail for other long-term gains.
So Palley is left with a rather tenuous assertion connecting the bubble and tax policy:
The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble.
I don’t think the tax preferences exactly hurt the cult’s marketing, but let’s face facts: to explain the bubble, it’s necessary to find factors associated more-or-less with the bubble era, and from that perspective it should be amply clear that the irrational exuberance came roaring out of the financial world. The cult part was all the spinning of tales for why houses were just like stocks in the late-90s except for the crashing back to earth part, combined with the deployment of financial technologies which, while not necessarily dangerous per se (*****), certainly bore risks of unintended consequences that were broadly ignored. So now we have a socialized financial system (at least on the downside), woohoo!
Meanwhile, I’m skeptical to say the very least regarding claims that we’d be living in a paradise of economic dynamism if only we were all unencumbered by our illiquid and inconvenient owned housing. Long-term wage stagnation is a huge problem, but one that can’t fairly be placed at homeownership above other causes.
So Palley has some reasonably sensible reform plans that someone might phase in, but I’m not going to tell anyone that a bit of political capital ought to be spent on them that might otherwise be spent extracting us from George and Dick’s Excellent Adventure or breaking our addictions to oil and/or GHG emissions — both of which are far more difficult and urgent.
(*) $80 billion is a lot of money, but at ~3% of the federal budget, not the biggest boondoggle in annual expenditures.
(**) Distastefully inefficient to the extent it’s true.
(***) Also true in large part, though non-itemizers do have the standard deduction.
(****) This is based on a constant-dollar income putting a 2007 taxpayer in the 28-percent bracket, not adjusted for other tax-law changes. Historical tax rates via the Urban Institute/Brookings Tax Policy Center.
(*****) If you think there’s something magical about 20%-down financing, go read the Irvine Housing Blog’s archives, handy link in the sidebar!