Homebuyer Subsidy Should Expire

November 2, 3:01 PMEugene Economic Policy ExaminerBen Rudin

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The Senate is voting today on extending the Homebuyer "Tax Credit." This "tax credit" gives people within a certain income range $8,000 if they are a first-time homebuyer, and this extension also expands it to give $6,500 to those who have owned their current house for at least 5 years and are buying a new house. You've probably noticed I've been putting words "tax credit" in quotation marks, and that's because "tax credit" is a euphemism. We have two kinds of tax credits, nonrefundable and refundable. The maximum one can receive in nonrefundable tax credits is the amount one paid in taxes. For example, if a person only paid $5,000 in taxes, even though the credit can be worth $8,000, the person can only get $5,000. However, this program is a refundable tax credit, or is given in full regardless of how much taxes the person pays. The only difference from a subsidy is in its name, but politicians like to call it a "refundable tax credit" because who doesn't like refunds and tax relief? I will explain why this program does more harm than good.

As I explain in my "What's the Goal of an Economy?" entry, the goal of an economy is not jobs, and it's not transactions. The goal is higher living standards. I also explain that taxes turn decisions that previously made economic sense into ones that don't, and subsidies turn decisions that previously didn't make economic sense into ones that do. Whenever the government injects money into the economy, the government first had to take that money out of the economy, causing people to give up stuff they would have bought on their own for stuff they would not have.

The same is true with interest rates. An artificially low interest rate turns decisions that didn't make economic sense into ones that do, and an artificially high interest rate does the opposite. Many culprits exist in the housing crisis, and an artificially low interest rate is one of them. The artificially low interest rate helped caused people to think they could afford a certain house when they couldn't, and take out loans for houses they could not afford, causing foreclosures. With an artificially low interest rate, the government essentially gave caffeine to the housing industry, propping up demand for it, and now we are experiencing a caffeine crash. We have two options: let the crash run its course and get the caffeine out of our system, or drink more caffeine.

The homebuyer's tax credit is more caffeine. Some people have been saving for a down payment on a house, and this simply speeds up the process. Sounds like it amounts to zero, as they will be buying a house now instead of later. That is true, but we need to remember the lesson of the broken windows fallacy: always account for what you don't see. Every dollar given to that homebuyer now is taken from others, and the loss of economic activity from them makes it less than zero. For those who otherwise would not buy a house, this works the same way as an artificially low interest rate and we are likely due for another bubble.

A better though still not great alternative would be to make this tax credit nonrefundable. Also as I mentioned in the entry, when the government reduces taxes, it is letting decisions it previously made not economical be economical again. With a nonrefundable tax credit, people simply get their own money back, and in this case, the government would simply be letting housing purchases that previously did not make economic sense to now make sense. There would be no redistribution, or increasing economic activity in one person by decreasing it in another. While it has these advantages over a subsidy, it's still not a good idea.

The problem with having this program, even nonrefundable, is the artificial disadvantage it gives everything else. The person gets money back for buying a house, but everything else still has to live with the tax disadvantage. Put another way, if you could get some of your tax money back, would you want it to be cash or a voucher for something specific? I'm guessing you'd say cash, because that would allow you to spend it on whatever you want based on your own happiness.

This program should expire, and if we really want to "stimulate" the economy, we should allow people to keep more of their own money and let them spend it on whatever they want.