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How to Better Encourage HomeownershipPublished: June 29, 2005 || Availability: Brief #12 from the series Tax Policy Issues and Options The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders. Note: This report is available in its entirety in the Portable Document Format (PDF). The way federal housing benefits are doled out across the population suggests a U-shaped curve: subsidies are heaped on those at high and very low incomes, with little going to all the low- to middle-income households in between. The federal government will disburse about $50 billion to renters in 2005—mainly through Section 8 vouchers or public housing—and nearly three times that in subsidies to homeowners through such tax incentives as the mortgage interest or real estate tax deductions. These subsidies raise the prices of owner-occupied housing while saddling subsidized renters with a hefty opportunity cost should they consider owning.1 By almost any standard, the distribution of housing benefits is inefficient and inequitable. One consequence is a lower homeownership rate among those who could well use the opportunity to start building assets. Homes, like pensions, are tax-preferred investments. Homeowners are not taxed on the fiscal rewards of owning their own home,2 nor are they taxed on the capital gains from the resale of the home.3 Homeowners can also deduct their real estate taxes and borrowing costs from their adjusted gross income. These special tax preferences likely contribute to higher housing prices for everyone, but especially where land is scarce.4 However, as this brief considers, simply eliminating these tax incentives would have significant consequences as tax filers adjusted their behavior. Homeownership rates reached an alltime high of 69 percent in 2004. For most middle-income households, housing wealth is the largest single source of savings, exceeding other assets such as pensions and personal savings. Homeownership serves not only as a financial solidifier, but also as a hedge against economic uncertainty and inflation. Moreover, owning a home correlates with greater educational attainment, greater likelihood of being married, better family outcomes, higher salaries, greater wealth, and increased ownership of other assets.5 This brief targets several reforms that would level out the U-shaped curve and deliver ownership subsidies more equitably and efficiently to households at lower income levels. This goal could be accomplished through a range of options described here, including several reforms of federal housing tax incentives—the mortgage interest and real estate tax deductions. Key considerations to be addressed in designing any comprehensive reform conclude this brief.
1. Economic theory asserts that a subsidy for homeownership can raise after-tax income and lower the after-tax price of owning, yet raise the before-tax price people are willing to pay. Thus, those with large subsidies for ownership may come out ahead, and those with zero or small subsidies come out behind, when price changes are taken into account. In the case of renters, on the other hand, rental subsidies are designed in such a way that renters forfeit this amount if they opt to buy a home, in addition to the costs of owning. In theory, the law provides that some of these latter rental subsidies could be converted to ownership, but in practice, for the most part, it simply is not allowed. For examples, see Rosen and Rosen (1980); Reschovsky and Green (1998); Green and Vandell (1999); Collins, Belsky, and Retsinas (1999); Olsen (2001); and Carasso, Bell, et al. (2005). 2. Since we typically think of the benefits of renting versus owning from the standpoint of cash flow, this concept can be elusive. A renter pays for the privilege to live somewhere, whereas an owner pays himself equity while getting to live somewhere "rent free." 3. Assuming the seller lived in the home (as opposed to renting it out) for two of the prior five years. See IRS Publication 523 for details. 4. More precisely, the increase in demand increases prices more where supply is more inelastic and supply factors, such as land, tend to be scarce. 5. The education and financial findings are indicated by direct correlation using the 2001 Survey of Consumer Finances. Duda and Belsky (2001) and Collins et al. (1999) catalog the research that underlies the social findings.
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