Monday, April 3, 2017

Housing: Part 217 - Some observations on taxes

I have found a pattern in home prices that I attribute to tax benefits, where high tier homes tend to sell at Price/Rent multiples of maybe 30% or more above low tier homes.  I think the price differentials we saw in Closed Access cities that were blamed on loose credit were actually a product of this factor.  In general, I would prefer to see the income tax benefits of homeownership removed, including the tax exemption of imputed rent, the deductibility of mortgage interest, and the exemptions on capital gains taxes.  The easiest way to do this, I think, would be to generally eliminate taxes on capital.  Many economists, as I understand it, would point out that taxes on capital aren't particularly progressive, because they really fall on owners, workers, and consumers proportionately after wages, prices, and profits adjust to the new equilibrium.  But, actually, I think capital taxation is a bit regressive because of these housing issues.  There is a huge gain to homeowners, especially high income homeowners, that would be difficult to get rid of as long as we tax capital income.  And, increasing property taxes a bit would capture back some of that tax revenue in a way that might be a little bit regressive, but is probably less regressive than the income tax benefits we currently have.

But, there is a caveat I hadn't thought of.  Property taxes are based on market values.  Market values currently reflect those income tax benefits.  So, property taxes are now somewhat progressive.  A home worth $1,000 in monthly rent now might sell for $150,00 while a $2,000 rental unit in the same town might sell for $400,000 (instead of $300,000).  That means that, by rental value, property taxes now are somewhat progressive.  Presumably, if the income tax benefits were removed, that high end home would only sell for $300,000, and their property taxes would also be lower.  So, my preferred tax regime would be more regressive than I have been admitting to.


There were some changes to the capital gains exemption in the 1990s.  It used to be that you could get an exemption on capital gains when you sold a home, but you had to purchase a new home or be over 55 in order to claim the exemption.  That requirement was removed in 1997.  This has generally been blamed, along with all the other tax benefits, for feeding the bubble, and I agree that the range of tax benefits does tend to inflate prices.

But, I think we may have overlooked the way that this actually made the bust worse.  As I have argued, there was a surge of permanent selling as early as 2003 or 2004 - homeowners selling and not buying back in.  With this change in the tax rules, households could bank their Closed Access capital gains, tax free.  In fact, if you were bumping up against the maximum ($500,000 for a couple), you might be induced to sell by that rule change, to reset your exemption.

Would the exit rate have been so high during the bust if that rule hadn't been changed?  I have to think that, at least, many of those sellers would have repurchased other homes.

These are tough arguments to make when most people think the problem was that the bust didn't come soon enough.  But, given that the bust was largely avoidable and unnecessary, this seems like an example of a disruptive unintended consequence.


Another piece of fuel to the fire was Bush's Mortgage Forgiveness Debt Relief Act of 2007.  Normally, a household would have to pay taxes on debt forgiven in a foreclosure.  But, seeing the mounting problem in the collapsing housing market, the Bush Administration signed this law in December 2007, providing relief from the tax consequences of foreclosure.

Coincidentally, by February, we were seeing articles like:
Homeowners: Can't pay? Just walk away. and Subprime loans defaulting even before resets. by February, as default rates suddenly spiked, and some homeowners appeared to be defaulting "strategically".

We have seen the bust as an inevitable result of the bubble.  It wasn't.  That has blinded us to the various discretionary policies that, in the end, did make it inevitable.


  1. Great blogging. In general, I think taxes have to be designed to reward (or at least not punish) working and investing, and whether progressive or regressive is not important.

    Later, if there is a desire, a nation can take care of the poor in a clear, above-board manner, such as monthly stipends.


    I have been pondering who owns multi-nationals.

    Yes, shareholders.

    But then, if you look at largest shareholders of any public company, they tend to be institutional, such as money managers, mutual funds, thus entities who manage money for anybody globally. Also, there are also a lot of ETFs out there now. Then there are limited partnerships that obscure true ownership, or offshore entities.

    Who owns multi-nationals? No one knows.

    Here are Chevrons top five shareholders:

    Vanguard Group, Inc. (The) 131,073,154 Dec 31, 2016 6.94% 15,427,309,832
    State Street Corporation 117,508,471 Dec 31, 2016 6.22% 13,830,746,684
    BlackRock Institutional Trust Company, N.A. 50,774,142 Dec 31, 2016 2.69% 5,976,116,361
    FMR, LLC 41,855,143 Dec 31, 2016 2.22% 4,926,350,205
    Capital World Investors 41,335,598 Dec 31, 2016 2.19% 4,865,199,760

    Thus we have the puzzle of the multi-national: Why should its revenues or income be attributed to any geographic region or nation?

    Siemens is German, but if they move 100 HQ employees to Ireland, do they become an Irish company? Legally yes. So their profits and overseas profits belong to Ireland and redound to the benefit of the Irish economy and citizenry? Irish per capita incomes rise, as reported?

    It may in fact be that the majority of shares in US-based multi-nationals are owned by US residents. The US economy is large and we have a lot of rich people and also public pension funds.

    But obviously there is a lot of mud in the water.

    1. Good points.

      Your point on progressivity is well taken. I, more or less, agree. In an environment where the political battle seems to always be about shifting marginal rates up in order to be progressive, this seems like an important point, though. If housing taxation is this screwed up and there is little hope of fixing it, then using the tax system as social engineering is a non-starter. We aren't capable of using this tool for that objective. I guess, in a round about sort of way, I'm trying to get to the same place you are.

      This regressivity is important in housing, though, because this gets capitalized into the price, creating all sorts of inequities and instability.


    makes some points that you do