Should the Home-Buyer Tax Credit Be Allowed to Expire?

The $8,000 first-time-home-buyer tax credit that's been helping juice the housing market is set to expire on Nov. 30. A lot of people don't want to see that happen. Since some of those people are in Congress, there's a decent chance the credit will be extended into 2010. Among the bills floating about are ones that would grow the amount to $15,000 and make all home buyers — not just those who haven't owned before — eligible. One policy-analysis shop puts the odds of some extension at 2 to 1, despite a cost that could run as high as $50 billion to $100 billion.

This makes little sense. Since the credit first passed last year, the logic of our financial rescue has evolved. The panic phase — the time when so many felt government had to act boldly and at any cost — has passed. Slowly, the free market is easing back in. Consider the federal guarantee on money-market mutual funds, which was slapped together a year ago to prevent a run on a key part of our financial system. That backstop expired on Sept. 18. It wasn't renewed.

In most realms, in fact, the return to normality is under way. Banks are paying back TARP funds. Cash for Clunkers has faded into the sunset. The chairman of the Federal Reserve Board has declared the recession over, and home prices are inching upward.

So why does the home-buyer tax credit persist? First, because of fear. Falling house prices, necessary though they were, triggered a lot of the mess we're in, and the thought of quashing a nascent recovery naturally leads to thoughts of another round of repercussions. Home sales have been growing for months, but a one-time pullback — like the one we saw in August — can still send chills down spines.

There's also political reality. Set aside for a moment the formidable lobbying power of real estate agents and homebuilders, as well as the fact that one of the Senate's biggest tax-credit boosters used to sell houses for a living, and you're still left with homeowners — also known as voters. Many of them have long asked their elected representatives why ordinary folks aren't getting more government help. A house-related tax break — whether or not it's good policy — sure does play well.

But this tax break probably isn't good policy, especially now that we seem to have left the darkest part of the housing-market woods. Here are the numbers. The IRS says 1.4 million first-time buyers have benefited from the credit so far; the National Association of Realtors thinks that figure will hit 1.8 million before the end of November. Meanwhile, a number of groups have estimated how many of those people wouldn't have bought houses had it not been for the tax break — about 350,000 or 400,000. In other words, some 80% of buyers would have bought anyway. In many markets, prices have fallen so far that houses are affordable in a way they haven't been in years — that's a reason to buy even without a gift from the government. We're giving up tax revenue on $11 billion that we don't need to.

On top of that, the way the tax credit is being implemented at times echoes certain practices that may have helped get us into the housing mess. For example, some state housing agencies are allowed to provide second mortgages to buyers who don't have enough money for a down payment so that they might "monetize" the tax credit and get the cash up front. Down-payment assistance is considered by many to have contributed to the crisis because it helped people buy homes they couldn't really afford. Anyone who doesn't understand that it's a bad idea to push people into buying houses when they're not ready to hasn't been paying attention for the past two years.

Worse yet, by extending the home-buyer tax credit, especially to existing homeowners, we run the risk of creating a situation where it never goes away. If a tax credit — or any other economic benefit — sticks around long enough, people start feeling entitled to it, even if it was originally supposed to be temporary. In academic literature this is called the endowment effect. Taking away such a program once it's ingrained can be a monumental political challenge. It's not just that expanding the home-buyer tax credit would cost $50 billion to $100 billion this year. It's that it could easily wind up costing that every year.

The question, then, is, Do we want to create a broad new housing-related entitlement?

To figure out the answer, we might look to an existing one: the mortgage-interest tax deduction. Each year we give up some $80 billion in tax revenues so that homeowners don't have to pay tax on the income spent on mortgage interest. The thing is, about half of homeowners don't claim the deduction; they don't see the benefit, nor do the one-third of people in the U.S. who rent a place to live.

The people who do see a meaningful benefit are, by and large, already rich. Economists James Poterba and Todd Sinai found that the tax savings from the mortgage-interest deduction for households earning more than $250,000 is 10 times the tax savings for households earning $40,000 to $75,000. According to Congress's Joint Committee on Taxation, a little more than half of the savings is seen by just 12% of taxpayers — those with incomes over $100,000.

The other interesting bit about the mortgage-interest deduction is that policymakers never intended it to help promote homeownership — something that many people assume to be the case and use to help frame their thinking about the appropriateness of using the tax code to boost home-buying. Rather, the deduction is an artifact of the 1894 federal income-tax code, under which all interest was deductible, since pretty much all interest was a business expense. There weren't really loans to buy houses back then. In other words, a massive and costly cornerstone of American housing policy isn't even something we chose.

The good news with the home-buyer tax credit is that we do, in fact, have a choice.