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Housing Stimulus: A Fine Mess of Good Intentions

Posted on April 23, 2008 by Martin A. Sullivan
Document originally published in Tax Notes
on April 14, 2008.


It's hard to know whether to laugh or cry. The taxwriting committees in Congress are coming to the rescue of the weak-kneed U.S. economy. As usual in the face of a national crisis, they are doing what comes naturally: doling out tax benefits to any business or individual remotely connected to the problem of the moment. This time the intended beneficiaries are supposed to be "home buyers, homeowners, and home builders."

Some of the provisions — there are 24 in the House bill alone — are so piddling or have so little to do with the current crisis that it is clear many of them were languishing on lobbyists' wish lists when this legislative go-round provided the perfect vehicle. Many of them are complex, which is bad enough, but because this is a stimulus bill, almost everything in it is temporary. So the afflicted industries and citizens have the privilege of learning all about laws that will soon disappear. They'll be lucky if the IRS writes all the rules before they expire.

From a policy perspective, all this messy tax law is based on wishful thinking. There is no good economic evidence that any of this stuff will actually help the economy. As Senate Finance Committee Chair Max Baucus, D-Mont., said on the Senate floor about the estimated $25 billion of refund checks going to businesses in 2009 and 2010: "We hope that this relief would encourage these businesses to rehire some of those workers who have lost their jobs." (Emphasis added.)

From a political perspective, however, "housing stimulus" is a sure bet. Collectively, members of Congress look like they are helping a struggling economy. Individually, the luckier and more powerful members are able to help curry favor with interested parties.

'Housing' Bill?

Let's start with the Senate bill the Finance Committee approved on April 3. By far the largest item in that legislation is the provision that would allow operating losses in 2008 or 2009 to generate refunds when those losses are carried back to offset prior profits over a four-year period (rather than the usual two years under current law).

The press release describing the net operating loss provision carries the title "Tax Relief for American Homebuilders." But there is nothing in the bill that limits the provision to home builders. What the release only hints at — and you have to be looking for it — is that the proposal applies to all corporations in all industries. The latest data from the IRS (for 2005) show that the entire construction industry is a small fraction of the corporate sector: 5.8 percent of returns, 1.8 percent of receipts, and 0.9 percent of net income.

Sure, construction may have a disproportionate share of losses over the next two years. But even if the construction industry accounts for 10 percent of losses, that means only about $600 million of the provision's estimated 10-year revenue cost of $6.054 billion goes to construction. In that case, because the estimated total cost of the Finance bill is $10.848 billion, only about half of that housing bill is going to the housing sector.

We can only guess the Finance Committee did not want to advertise the tax benefits going to other losing businesses, like big banks and Wall Street investment firms. "Tax Relief for New York Bankers" just would not do.

Credit on Credit

The oddest tax provision in this housing legislation comes from the bill the House Ways and Means Committee approved last week. Section 131 of the Housing Assistance Tax Act of 2008 would create new section 36, laying out the rules for a new first-time home buyer credit. For a one-year period beginning on April 9, 2008, first-time home buyers purchasing a principal residence will be eligible for a refundable tax credit. The credit amount is $3,750 for individuals and $7,500 for married couples. The credit is phased out for home buyers with income in excess of $70,000 ($110,000 in the case of a joint return).

So far, so good. The normal stuff. But then, to save revenue for House Democrats who are on a self-imposed tight budget — that is, they are abiding by "pay as you go" budget rules — beneficiaries of the credit would be required to pay back the credit over 15 years. According to the estimates, about 1 million new homeowners will qualify. Married couples, even if they have no other income tax liability, will have to pay the IRS an extra $500 for 15 years. So technically this mechanism is a tax credit with a 15-year recapture, but it works like an interest-free loan from the IRS.

This is a strange provision — first, because there is nothing like it in current law. Second, it is not clear how this credit — which is supposed to help home buyers make a down payment — will get into the hands of borrowers in a timely manner, especially since the credit is paid to the taxpayer over two years. Finally and most important, besides being bad tax policy, it is lousy banking policy. We are now in a credit crisis in which loose lending standards are the heart of the problem. One of the first rules of sound mortgage borrowing is: Do not borrow to make your down payment. But under the home buyer credit provision, the U.S. government would be encouraging it.

The Senate bill also has a temporary home buyer credit, but it is very different from the Ways and Means version. Proposed new section 25E would provide a nonrefundable credit of $7,000 (for married and single taxpayers). There is no phaseout for higher- income taxpayers. Unlike the House bill, the credit is available only for "single-family structures" — so it seems purchasers of condominium and co-op units are out of luck.

The difficult aspect of the Senate home buyer credit is that the credit is available only for purchase of principal homes "upon which foreclosure has been filed pursuant to the law of the state." Also, to be eligible, the resident must meet one of two requirements.

First, the home must have been built before September 2007 (about the beginning of the mortgage crisis) and never have been occupied. That will help clear homebuilders' existing inventories. Alternatively, the home must have been occupied by the foreclosed mortgagor for at least one year.

The credit thus provides an incentive to purchase foreclosed homes. But doesn't it also provide an incentive to foreclose? With increased buyer demand for foreclosed homes, banks and finance companies now have less reason to work out refinancing with existing owners.

Property Tax Relief

Both the House and Senate bills provide a temporary above-the- line deduction for property taxes for homeowners who do not itemize. The Senate is more generous, proposing a $500 deduction for singles and $1,000 for couples, while the House offers only a $350 deduction for singles and $700 for couples.

The Senate would deny the deduction to any taxpayer whose local government increases property taxes after April 2, 2008, and before January 1, 2009. Presumably that is to prevent the locals from using the federal tax benefit as an excuse to raise property taxes. But that feature creates more mischief than it is worth. Some cash- strapped local government will pass tax increases anyway, and then the unfortunate homeowners get the double whammy of denial of the federal tax credit and a property tax increase. Other municipalities needing to increase taxes will simply find ways to delay the increase until the end of 2008.

Other Provisions

Most of the other provisions of these bills are expansions of existing programs. The Senate bill adds $10 billion of tax-exempt private activity bond authority for refinancing, first-time home buyers, and multifamily rental housing (10-year cost: $1.7 billion).

The House bill would provide additional low-income housing credits at a cost of $2.5 billion and would relax tax-exempt bond rules at a cost of $2 billion. There's also $1.8 billion of relief from the alternative minimum tax for both tax-exempt bonds and the low-income housing credit. Real estate investment trusts would get $400 million.

REITs invest mostly in commercial real estate. According to data from the National Association of Real Estate Investment Trusts, in the third quarter of 2007 REITs had $52 billion of equity investment and $8 billion of financing in residential real estate. Total market capitalization for publicly traded REITs was $366 billion. (NAREIT Chart Book, Jan. 2008, p. 18, available at /taxbasehttp://www.nareit.com/library/performance/CB0801.pdf.) So about 16 percent of the REIT relief in the Ways and Means housing bill would go to the housing sector.

Veto?

With strong bipartisan support in both chambers, passage of a compromise version of these tax bills — as part of larger, general housing relief legislation — is expected soon, perhaps this week. President Bush is strongly opposed, but can he really stop this steamroller? With luck, the veto threat will trim some of the excesses.