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HOMEOWNERSHIP TAX CREDIT

Key Points

·        The proposal converts the first-time home buyer credit from an interest-free loan to a cash grant in the form of a non-refundable tax credit of 10 percent of home purchase price, up to a maximum $15,000 credit, for all home buyers—regardless of income—who purchase a home within a year of the stimulus bill’s enactment.

·        The provision is likely to speed up some home purchases, providing a very modest temporary boost to the housing market.

·        Making the credit available to all homebuyers increases the cost with the largest benefits going to higher-income people who would have bought houses anyway.

·        JCT estimates that the proposal would cost an estimated $39.2 billion over 10 years.

Current Law

First-time homebuyers are allowed a refundable tax credit equal to the lesser of $7,500 ($3,750 for married-filing-separate returns) or 10 percent of the purchase price of a principal residence. The credit phases out for individual taxpayers with modified adjusted gross income between $75,000 and $95,000 ($150,000 and $170,000 for joint filers). To qualify, the taxpayer must not have owned a home during the three years prior to purchase. In addition, taxpayers are ineligible if they claim the D.C. homebuyer credit (a $5,000 nonrefundable tax credit for qualifying purchases in Washington, D.C.) or if their home is financed with tax-exempt mortgage revenue bonds (low-interest rate mortgages).

The credit is basically an interest-free loan from the government and must be repaid in installments over 15 years. It must also be repaid if the taxpayer sells the home or stops using it as a principal residence. However, the amount repaid is limited to the gain (if any) on sale. (To calculate gain, the taxpayer’s cost basis is reduced by the amount of the credit.) There is no recapture if a taxpayer dies.

The provision applies to purchase between April 9, 2008, and June 30, 2009. Taxpayers who buy a home in 2009 may elect to claim the credit on their 2008 tax returns (with recapture starting in 2010).

Proposal

The proposal would 1) double the maximum value of the credit; 2) make the credit available to all homebuyers, not just new buyers; 3) make the credit non-refundable; 4) waive the repayment requirement; 5) redefine qualifying homes as those purchased within a year of the stimulus bill’s passage; 6) remove the income limits; 7) reduce to two years the time buyers would have to live in their new homes; and 8) allow homebuyers to claim the credit over two years. Effectively, the homebuyer credit would become twice as large and convert from an interest-free loan into a cash grant.

Discussion

The proposal would temporarily increase the demand for owner-occupied housing by reducing the after-tax cost for home purchasers. The higher demand is likely to increase the sale price and shorten the average time on the market of owner-occupied housing units, with the greatest effect on moderate-priced housing. That is, part of the benefit of the tax subsidy will accrue to home sellers. To the extent that the credit encourages people to move from renting to owning, it is likely to also increase rental vacancy rates, depressing slightly the value of rental real estate. In addition, taxpayers who can claim the credit would likely buy somewhat better (more expensive) homes than they would without the credit.

The proposal would provide a windfall to taxpayers who already planned to buy a home and would encourage some taxpayers who were thinking about buying to speed up their purchases so the sale could be completed during the eligible time frame. If taxpayers believe the credit will expire as scheduled, it would build in an automatic after-tax price increase—offsetting the deflationary expectations in the housing market. Currently, with house prices falling, buyers may perceive that they are better off waiting, which further weakens demand for housing and can lead to further price declines. If the credit expires as scheduled, homebuyers could save $15,000 if they buy before the end of the one-year window.

While the temporary proposal could have no more than a modest effect on the housing market, the windfalls to homebuyers would provide a modest stimulus. The credit would be timely but it is poorly targeted, since most of the benefits would go to people who would buy houses anyway. The tax credit would not be refundable, reducing its value for households with modest incomes. With no income limit, much of the value would go to higher-income families, who have sufficient tax liability to claim the full credit. Those households are least likely to spend the additional funds the credit would provide, so the stimulus effect would be reduced. Homebuyers could claim the credit, however, on their 2008 tax returns, meaning that it could raise after-tax incomes fairly quickly if taxpayers either completed their sale before they file or if they chose to file an amended tax return after qualifying for the credit.

There will thus be enormous pressure on policymakers to extend the scheduled expiration date beyond its one-year limit. Some purchases in the works at the end of that year will not be completed in time to qualify and those buyers will lobby for extension. Home sellers, builders, and realtors will also want to extend the expiration date because the real estate market is likely to remain soft for more than a year, and the drop off in demand when the credit expires would tend to depress the market again. There will also be pressure to remove repayment requirements for people who claimed the current credit.

As a long-term measure, however, the proposal would increase the tilt in the tax code in favor of owner-occupied housing. Owner-occupied housing is already very heavily subsidized, resulting in too much investment in homes and not enough in other productive assets. This is both inefficient and inequitable and may have contributed, in part, to the housing bubble. (If the cost of a permanent homebuyer credit were financed by reductions in other housing tax expenditures, such as the mortgage interest deduction, the proposal could improve equity by retargeting housing subsidies at those with lower incomes and expand homeownership (see Gale et al. 2007).)

However, one advantage to the modified credit is that it would be much simpler than the current provision. Recapture over 15 years requires fairly extensive record keeping and annual reporting, which, under this proposal, would not be necessary for taxpayers who remain in their homes for at least two years.

Grade: D+

The proposal would raise incomes of some middle-income and high-income families, boosting consumption slightly, and it would be very timely. Its availability to all homebuyers makes it very expensive and provides large windfalls to many households without changing their behavior. Furthermore, it is likely to do little to solve the housing market’s problems. There is a substantial risk that the credit would be extended, which would be undesirable unless other housing tax subsidies were scaled back.

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