Congress Would Be Foolish to Extend the Homebuyer Tax Credit
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The surprise decline in August existing home sales should have put an end to talk of extending the first-time homebuyer tax credit, which was passed as part of February’s stimulus package. Most analysts anticipated a surge in August sales as first-time homebuyers rushed to take advantage of the $8,000 refundable credit prior to its November 30 expiration. The prevailing paradigm had been that the program was “pulling forward” sales that would have otherwise occurred next year. The anticipated hangover in 2010 sales (resulting from this “pull forward”) was the main rationale behind the six bills pending in Congress to extend it. Given the unlikelihood that the tax credit will stimulate many “additional” sales, it is disappointing that talk of extending the tax credit into 2010 continues. Major trade groups are already lobbying the Administration to extend the credit, claiming that the credit was responsible for 355,000 home sales that would not otherwise have occurred – a figure many experts disagree with.
The credit was always a questionable use of taxpayer resources. Any tax credit for home purchases goes to two classes of homebuyers: (1) the marginal homebuyer for whom the tax credit serves as his primary motivation to enter the market; and (2) all other homebuyers for whom the tax credit is pure windfall because they would have made the purchase anyway. Delineating between these two classes is difficult, especially when the credit applies not to “true” first-time buyers, but to those defined in statute as anyone who had not owned a home in the previous three years.
According to the IRS, 1.4 million taxpayers had taken advantage of the credit by the middle of September, 2009. With 3.5 million existing homes and 263,000 new homes sold in the U.S. through August, this means roughly 39% of all home sales have involved eligible first-time buyers. That may seem like a nice yield on the more than $11 billion tax expenditure until one considers that first-time buyers accounted for between 36% and 42% of all home purchases from 2001 to 2008. In other words, eligibility for the credit has had no impact on the relative rate of sales.
Proponents of the tax credit respond by explaining that for an existing homeowner to “move up,” a first-time buyer must enter the market. Therefore, the credit’s effectiveness should not be measured by the percentage of first-time sales, which would be expected to remain roughly constant, but by the total number of sales facilitated by the credit. Those estimates range between 165,000 (National Association of Homebuilders) and 600,000 (National Association of Realtors). Both estimates include first-time sales as well as the re-sales those purchases facilitate.
This means that under the most optimistic estimate the program is giving away $1.33 for every $1 used to stimulate a sale. Under the more probable estimate, it’s $7.50 of pure windfall for every $1 of stimulus. And while there’s some truth to the notion of first-time buyers comprising a constant range of all sales, one would expect first-time buyers to account for a larger percentage of purchases this year simply because the fall in housing prices has been a huge inducement for non-owners to enter the market. At the top of the bubble, the percentage of purchases made by first-time buyers fell to a 20 year low of 36%. Soaring home equity values were the boost existing homeowners used to purchase new homes, which created an affordability gap for first-time buyers. With the price elasticity of demand for housing estimated to be –0.75, the 30% decline in national housing prices since 2006 has likely done much more to bring first-time buyers to market than a tax credit with a 30-year amortized value of $40 per month.
Even in the face of many critics who say extending the tax credit is an inefficient way of stimulating the economy because it simply helps people who would have bought a home anyway, one Senate draft bill shockingly contains a provision to broaden the credit to cover all buyers of a principle residence, not just first-timers, at a cost of $16.7 billion.
Perhaps the only first-time buyers for whom the credit is truly making a difference are those who might be better off not buying. The dramatic decline in underwriting standards that precipitated the mortgage crisis not only involved low credit scores, but also low and no down payment loans. No down payment loans dramatically increase the probability that the borrower will one day have negative equity, which is the most significant contributor to defaults. This was partly why lawmakers did not allow the credit to be used for closing costs or down payments. Yet, the website of the National Association of Home Builders provides instructions explaining how a homebuyer can circumvent this prohibition through a “bridge loan.” And this method of reintroducing no down payment mortgages was a deliberate policy choice of the Obama Administration. Policymakers should heed the lessons of the recent past and recognize that there is such a thing as too much policy support for housing. Allowing the homebuyer tax credit to expire would help to level the housing playing field – and reduce the prospect of future volatility in mortgage markets.