Secret #59 – We Have 2 Completely Different Tax Codes for Single-Family Houses – 1 for Live-in Owners and 1 for Landlord Owners – Which Distorts the Market for Single-Family Houses
Secret #59 – We Have 2 Completely Different Tax Codes for Single-Family Houses – 1 for Live-in Owners and 1 for Landlord Owners – Which Distorts the Market for Single-Family Houses
An excellent point. But in economics we always need to look beyond the problem and proposed solution. The following is not to defend or support your proposal as stated - I tend to agree from a fairness aspect. But we need to look at the problem from all angles - we need to look at possible 2nd and 3rd order effects.
1. Change tax code so that live-in home owners get the same tax breaks as landlords and vice versa (depreciation, mortgage interest, etc) - the most obvious 2nd order effect of this solution is that the tax base decreases dramatically. The most recent Tax Expenditure Budget (https://home.treasury.gov/system/files/131/Tax-Expenditures-FY2023.pdf) notes that individual tax breaks sum to about $1.6 trillion dollars (compared to corporate tax breaks at $162 billion in cost - revenues the government doesn’t collect due to the break). Without going deep into the specifics, one can conclude that extending tax cuts to homeowners will increase this expenditure resulting in further government deficits. Possible 3rd order effects from this are the increasing monetization of government debt and therefore increased inflation. Not to mention the possible asset/ market effect of increasing residential property values which could make the housing affordability even more of an issue (especially for the lower income population).
2. Change tax code so that all residential real estate tax breaks are eliminated: on the surface this will increase government revenues which would be a great thing for our national debt. We might even call it Austerity. Perhaps it would limit future inflation. BUT! What will this option do to home prices and the housing market? Investors might flee the market place and look elsewhere for investments. This might flood markets with new listings and depress asset prices across the board. This would be great for housing affordability and people who do not own homes. But it would hurt current homeowners and a whole lot of people might be underwater. Maybe this decreases prices further in a nasty feedback loop. This scenario would also hurt the residential construction industry for a long while. So it might be good today but be terrible in the long run if we find ourselves in a housing stock dilemma a decade or so from now. This course might also cause a lot of layoffs and unemployment in the construction and services industry - the housing industry is HUGE at about 15% of GDP). If the effect is bad enough, we enter another 2008-like scenario. Maybe even Depression. Housing is such a big part of the economy that a devaluation/ deflation in the sector would have numerous feedback loops across the board (e.g. a spike in unemployment reduces income tax revenues and expenditures as the government spends to solve that problem thereby increasing the deficit). Who knows how long it would take for that mess to correct? If I go deep enough into the consequences rabbit hole, I can even imagine a scenario where this has the paradoxical effect of decreasing individual home ownership in favor of corporate home ownership if the prices get low enough that the investment makes sense to the wealthy despite no tax breaks - if the imagined recession/depression is bad enough, perhaps corporations and the wealthy are the last ones able to actually purchase houses and end up holding the whole bag. These are very much worst case imaginations but stranger things have happened.
3. Change tax code to favor live-in homeowners over investors (in other words, more tax breaks for the former, less for the latter): maybe this is the most “fair” option. Perhaps this is the option with the least overall consequence. But I still envision a world similar to Option 2 where the housing market is depressed as liquidity flees the market place. Then construction of new housing slows, etc. I still think this would have a depressing effect on the housing market that could very well infect the rest of the economy. I also envision a world where the investor class, as sophisticated as they are, react in a way where they do not outright own homes but own them in truth (much like the mortgage owner actually owns the home in truth if not in fact until the mortgage is repaid). Perhaps they all start forming S&Ls or credit unions (who also have tax breaks).
Conclusion: be careful deriving an ought from an is. Any dramatic shift in the current tax structure will absolutely have 2nd, 3rd (and more) effects on the economy. And I think we are in a precarious enough position (in all aspects) that maybe taking a breath and making small changes is the best course. The most dangerous effect is probably one that can’t even be imagined or deduced rationally. Not that my opinion matters that much in the aggregate, but I would support option 3 as long as the changes are small and incremental over time (you know, the frog in a slowly heating pot thing). The most drastic and dramatic changes tend to have the most devastating effects (e.g. dramatic increase in Fed Funds rate in 2022-2023 and its effect on the housing industry).
I'd go with #2 for new purchases by investors. The transition is the hard part, especially now that we're at the top of the cycle. Would need some temporary, transition measures to reduce those 2nd order effects. The goal of U.S. government policy should be to have stable, sustainable house price increases and no price decreases.
In an ideal world, I agree. In such a world, I’d go further and propose to make the tax system uber-simple, progressive, with zero breaks, and treating corporations just like individuals (same tax structure, no breaks). This world also incorporates a balanced budget with government revenues never exceeding 10% of GDP (lesser the better). Let’s go ahead and throw in congressional and judicial term limits and make trading on inside information illegal for all politicians. Hey, we can dream, right?
For the record, I agree with your analysis and agree that it is not a fair system. I also agree that we should strive toward an ideal and get better where we can (as a nation we’ve done pretty well at this in the aggregate). But I think I understand human nature enough to not assume that all will go according to plan. There will always be reaction, counter-reaction, greed, favoritism, rent-seeking, unintended consequences, Black Swans, etc. Thus we are doomed to cycles - booms and busts are not going anywhere.
So count me very skeptical that any proposed solution would produce anything akin to a stable and sustainable market. The Fed has certainly been incapable of controlling the economy to produce such a thing despite honest(?) attempts. And that body is composed of very educated, very intelligent, and (mostly, probably) well-intentioned individuals.
One advantage of getting rid of single-family house landlord tax breaks is that it stabilizes prices without being dependent on a government bureaucrats always making the right decisions. Sometimes government agencies (the Fed) will make wrong decisions ("transitory" inflation). And it's free. You don't have to pay for a government agency to administer it, e.g., the Fed.
An excellent point. But in economics we always need to look beyond the problem and proposed solution. The following is not to defend or support your proposal as stated - I tend to agree from a fairness aspect. But we need to look at the problem from all angles - we need to look at possible 2nd and 3rd order effects.
1. Change tax code so that live-in home owners get the same tax breaks as landlords and vice versa (depreciation, mortgage interest, etc) - the most obvious 2nd order effect of this solution is that the tax base decreases dramatically. The most recent Tax Expenditure Budget (https://home.treasury.gov/system/files/131/Tax-Expenditures-FY2023.pdf) notes that individual tax breaks sum to about $1.6 trillion dollars (compared to corporate tax breaks at $162 billion in cost - revenues the government doesn’t collect due to the break). Without going deep into the specifics, one can conclude that extending tax cuts to homeowners will increase this expenditure resulting in further government deficits. Possible 3rd order effects from this are the increasing monetization of government debt and therefore increased inflation. Not to mention the possible asset/ market effect of increasing residential property values which could make the housing affordability even more of an issue (especially for the lower income population).
2. Change tax code so that all residential real estate tax breaks are eliminated: on the surface this will increase government revenues which would be a great thing for our national debt. We might even call it Austerity. Perhaps it would limit future inflation. BUT! What will this option do to home prices and the housing market? Investors might flee the market place and look elsewhere for investments. This might flood markets with new listings and depress asset prices across the board. This would be great for housing affordability and people who do not own homes. But it would hurt current homeowners and a whole lot of people might be underwater. Maybe this decreases prices further in a nasty feedback loop. This scenario would also hurt the residential construction industry for a long while. So it might be good today but be terrible in the long run if we find ourselves in a housing stock dilemma a decade or so from now. This course might also cause a lot of layoffs and unemployment in the construction and services industry - the housing industry is HUGE at about 15% of GDP). If the effect is bad enough, we enter another 2008-like scenario. Maybe even Depression. Housing is such a big part of the economy that a devaluation/ deflation in the sector would have numerous feedback loops across the board (e.g. a spike in unemployment reduces income tax revenues and expenditures as the government spends to solve that problem thereby increasing the deficit). Who knows how long it would take for that mess to correct? If I go deep enough into the consequences rabbit hole, I can even imagine a scenario where this has the paradoxical effect of decreasing individual home ownership in favor of corporate home ownership if the prices get low enough that the investment makes sense to the wealthy despite no tax breaks - if the imagined recession/depression is bad enough, perhaps corporations and the wealthy are the last ones able to actually purchase houses and end up holding the whole bag. These are very much worst case imaginations but stranger things have happened.
3. Change tax code to favor live-in homeowners over investors (in other words, more tax breaks for the former, less for the latter): maybe this is the most “fair” option. Perhaps this is the option with the least overall consequence. But I still envision a world similar to Option 2 where the housing market is depressed as liquidity flees the market place. Then construction of new housing slows, etc. I still think this would have a depressing effect on the housing market that could very well infect the rest of the economy. I also envision a world where the investor class, as sophisticated as they are, react in a way where they do not outright own homes but own them in truth (much like the mortgage owner actually owns the home in truth if not in fact until the mortgage is repaid). Perhaps they all start forming S&Ls or credit unions (who also have tax breaks).
Conclusion: be careful deriving an ought from an is. Any dramatic shift in the current tax structure will absolutely have 2nd, 3rd (and more) effects on the economy. And I think we are in a precarious enough position (in all aspects) that maybe taking a breath and making small changes is the best course. The most dangerous effect is probably one that can’t even be imagined or deduced rationally. Not that my opinion matters that much in the aggregate, but I would support option 3 as long as the changes are small and incremental over time (you know, the frog in a slowly heating pot thing). The most drastic and dramatic changes tend to have the most devastating effects (e.g. dramatic increase in Fed Funds rate in 2022-2023 and its effect on the housing industry).
I'd go with #2 for new purchases by investors. The transition is the hard part, especially now that we're at the top of the cycle. Would need some temporary, transition measures to reduce those 2nd order effects. The goal of U.S. government policy should be to have stable, sustainable house price increases and no price decreases.
In an ideal world, I agree. In such a world, I’d go further and propose to make the tax system uber-simple, progressive, with zero breaks, and treating corporations just like individuals (same tax structure, no breaks). This world also incorporates a balanced budget with government revenues never exceeding 10% of GDP (lesser the better). Let’s go ahead and throw in congressional and judicial term limits and make trading on inside information illegal for all politicians. Hey, we can dream, right?
For the record, I agree with your analysis and agree that it is not a fair system. I also agree that we should strive toward an ideal and get better where we can (as a nation we’ve done pretty well at this in the aggregate). But I think I understand human nature enough to not assume that all will go according to plan. There will always be reaction, counter-reaction, greed, favoritism, rent-seeking, unintended consequences, Black Swans, etc. Thus we are doomed to cycles - booms and busts are not going anywhere.
So count me very skeptical that any proposed solution would produce anything akin to a stable and sustainable market. The Fed has certainly been incapable of controlling the economy to produce such a thing despite honest(?) attempts. And that body is composed of very educated, very intelligent, and (mostly, probably) well-intentioned individuals.
One advantage of getting rid of single-family house landlord tax breaks is that it stabilizes prices without being dependent on a government bureaucrats always making the right decisions. Sometimes government agencies (the Fed) will make wrong decisions ("transitory" inflation). And it's free. You don't have to pay for a government agency to administer it, e.g., the Fed.