Tax changes as a tipping point?

Could changes in the federal tax code have been a "tipping point" that led to the housing bubble?

An article in the International Herald Tribune today takes an in-depth look at the issue:

By itself, the change in the tax law did not cause the housing bubble in the United States, economists say. Several other factors -- a relaxation of lending standards, a failure by regulators to intervene, a sharp decline in interest rates and a collective belief that house prices could never fall -- probably played larger roles.

But many economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17% higher over the last decade than it would have been without the law. ...

By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than as a place to live. It helped change the national conversation about housing. Not only did real estate look like a can't-miss investment for much of the last decade, it was also a tax-free one.

Together with the other housing subsidies that had already been in the tax code -- the mortgage-interest deduction chief among them -- the law gave people a motive to buy more and more real estate.

And don't forget to factor in human nature and our nation's "get rich quick" mentality.

--Lauren Beale

Thoughts? Comments?   

Photo: A home for sale in Sacramento. Credit: Rich Pedroncelli / Associated Press

Comments

[sunsetbeachguy]

This is like the blaming the CRA idiocy.

Tax changes for owner's made the investment banks abandon 4,000 years of lending knowledge and blow this bubble.

The stupidity is blinding.

[PeteR]

Hold tight, Lauren. Barack and Michelle, aka Joseph and Mary, will heal the country of its get-rich-quick mentality. Everything will be Fine (TM) again with the Blessed Ones presiding over the nation.

[Laker]

"....the tax raised relatively little revenue — perhaps just a few hundred million dollars in today's terms...."
That is a load of crap. if there was capital gains tax on the sales of homes between 2000-2007, hundreds of billions would be collected in tax. Sellers cashed out so much. Look at the inflation of the housing valuation from $3 Trillion to $10 trillion. just about 10% tax on the $7 trillion gain, you get $700 Billion. Even if you assume 5% capital gains tax, you get $350 billion.

[Pasadena'd]

PeteR, sorry the election didn't go your way, but don't think for a minute that the bitterness you hold is going to be masked by an attempt to look like you're actually contributing to the topic of conversation.

Lauren, you're own suspicion holds more merit, IMO. "Get rich quick" plus a healthy dose of "false sense of entitlement" is what I've seen among my peers who are very deep underwater with their mortgages. One already folded and took "voluntary" foreclosure.

Lastly, as many have already asked, what's up with LA Land getting tossed off the Blogs main page? Is this an editorial decision or did one of the web developers screw up?

[Vindicated]

Please... as sunsetbeach said above the only reason why this bubble happened was because, for some reason, people/business/banks/corporations bought loans that they should have known would never be paid back. This whole mess is so simple it's disgusting.

[firesale]

A decade or two of, "I'll never buy real estate, again!"
... and things will be back to normal. Real estate as
an investment needs to be dragged through the gutter
by the ring in its nose.

How about balancing out the RE madness with tax-free
interest on one's first half-million in cash savings.

[xtine]

Lauren - I have started reading this blog again....because you have really really started to comment on what's out there and draw me in with your quick, insightful analysis.

Thanks!

[bigunit]

Reinstating a significant capital gains tax is likely to remove a major driver in the overall economy forever: the trade-up buyer. You think we're in the doldrums now, this would really slow buying & the incentive to buy.

[Cal]

The one good thing about taxes during the internet bubbe is that it created a cushion that helped relieve some of the pain coming out the other side. Unfortunately people just jumped into the next bubble instead of learning from the previous one (a relatively unique event in history in that regard) and that next bubble didn't have the tax revenue cushion built up and in fact had the opposite issue of increased spending. Bubbles are bad but having higher taxes during the good times ensures the bad times aren't so bad. While it seems logical to drop taxes while things are going well it creates more volatility and unstability to the marketplace. It is better to have taxes high during the good times and low taxes during the bad times to reduce volatility and promote stable growth.

PeteR, you have some serious issues, we have massive problems that the next president has to clean up. Both parties share the blame and if you look back in history the Republicans have had the majority of power since 1995 (controlling Congress and the white house the majority of time) . The next president is just screwed and facing almost unprecedented level of issues (2 wars, massive deficit and a failing financial system) leftover by the previous administration. I hope Obama is the messiah because we need a miracle.

[PeteR]

Pasadena'd, thank you for the kind words, but Lauren must get the credit for the Barack-and-Michelle-as-Joseph-and-Mary idea.

http://latimesblogs.latimes.com/laland/2008/12/photo-of-the-we.html

The rest is mine, however, so I deeply appreciate your praise.

[cb]

An opinion from Australia (having moved back here from the LA area in 1999, damn wish I didn’t sell the house until a few years later but hindsight is 20:20…):
Owner-occupied homes are capital gains exempt here, and yes it definitely encourages the ordinary homeowner to plough money into their home rather than invest it elsewhere. We had a market “correction” around 2003 (down about 30%) after a boom in 2002, and it has stayed reasonably flat since. Yes there were loc-doc loans going on but having had to do one myself being self-employed I found the banks still made me substantiate my earnings. However we won’t be immune, people here have loans they couldn’t afford (especially when our standard variable rates went over 9% and they are the norm here), if unemployment hikes up I am sure our market will drop some. First home-buyers will be happy with more affordable homes and lower interest rates… the cycle will continue…
The thing about cycles... you usually know where in the cycle you are, just not how long you’ll be there or how high or low it will go. Oh for a crystal ball…

[JR]

Lauren, you are doing a great job with this blog! How about asking fellow bloggers to write about the favorite real estate blogs in Los Angeles? It could be an interesting way to hear what people think about these new types of interactive forums.

A few of my favorites are:

1) Westside Bubble
2) WestsideREmeltdown
3) Santa Monica Distress Monitor

and of course,

4) LA Land Blog

Keep up the good work!

[syscom3]

Every single person I know who bought a home the past eight years did it for one purpose only.

A place to live.

Investment purposes were incidental and not planned on.

[Jacinto]

Shall we keep in mind there weren't a lot of cap gains paid under the old law either. A cap gain on a personal residence was suspended as long as the seller bought another personal residence worth as much or more as the one he sold. Most people did.

We might argue the new law is a bit too generous, but the 1 out of 6 figure about increased sales means the new law can't be a major cause of the bubble.

By the way, home buyers in most countries pay sales tax on the purchase. Lets hope we don't pick up too many foreign elements of public finance.

[Bubblewatcher]

The capital gains exemption may not, in practical terms, have single-handedly precipitated this bubble, but having this exemption, along with the deductability of mortgage interest, sure gave those Used House Salesmen a new and interesting sales point to spin. The weird math of "guaranteed gains" depended upon them.

[Enlightenment]

Raise House Taxes!!!!!!!!!!!!!!!!!!

[xtine]

SYSCOM - I have the same experience. Every person I know lived in their house.

However, they also regurgitated a lot of investment-style garbage over dinner to excuse the obscene price they were paying:

1) With the tax write-off we save money!
2) We'll just refinance our ARM in 5 years.
3) Our house is already worth 100K more than we paid for it.

All of these people fell for the investment snowjob WHILE THEY WERE LIVING IN THE HOUSE. And nothing I said could turn them around.

I don't think I have to describe where they're living now.

[WatchingInMalibu]

My take is that the $500k limit on the capital gains tax deduction is actually helping higher end places hold their value. In our area, we know a number of folks with gains way above this mark doing one of two things (a) simply deciding to not sell and stay in their place, reducing "move up" inventory and forcing prices up, or (b) move, but not putting their place on the market, instead leasing it - again, reducing "purchase" supply. What we don't know is anyone who has actually paid the taxes on the gain - though there must be someone somewhere.

It makes me wonder whether taking every dollar of gains on sales of a home with no exemption might actually help drive prices even higher in the nicer areas, since so few people would be willing to sell, and you'd see supply shrink quickly.

[bigjimslade]

While the NY Times looked like a typical Democratic snow job, they did at least give some credit to the role of minorities not paying off their loans. I attribute almost all of the rest of this to human greed. I think we're all going to have to go back and start working a lot harder.

[Mary C.]

I think the change in the law, made by Bill Clinton, was a big impetus to a run-up in housing values. I know people who benefited from it and did move up. The problem is there are never going to be enough people on the bottom to buy the starter houses without funny financing or making the prices in line with some fairly low incomes (hence, the price crash/correction). The banks probably based their rosy projections on housing based on that giant tax loophole. Also, the tax code changes under Reagan made home mortgages the sole tax deduction most people could take. Before, interest on other types of loans was also deductible. It was more fair to renters (and didn't encourage ownership as much), and also made people not see their house as a bank, as that deduction does. People used home equity loans to buy things not under the housing category, and used that deduction to prop up things like car purchases. Now, people can't get home equity loans, and car sales are crashing.