How the Homebuyer Tax Credit “Works” a Lot Like Cash for Clunkers

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The news from Thursday’s Washington Post:

The Senate voted Wednesday to renew the government’s $8,000 tax credit for first-time home buyers through the first six months of next year as part of a broader bill designed to extend unemployment benefits.

For the first time, the tax credit program would also enable many homeowners who buy a new primary residence to receive a $6,500 refund.

The news from Thursday’s Washington Post:

The Senate voted Wednesday to renew the government’s $8,000 tax credit for first-time home buyers through the first six months of next year as part of a broader bill designed to extend unemployment benefits.

For the first time, the tax credit program would also enable many homeowners who buy a new primary residence to receive a $6,500 refund.

The measure was attached to a bill that would provide 20 weeks of unemployment benefits in more than two dozen states with jobless rates above 8.5 percent and up to 14 weeks elsewhere. Another provision in the bill would allow businesses that had operating losses in 2008 and 2009 to seek refunds for taxes paid on profits over the past five years.

Why this legislation now?  Because despite signs that the economy as a whole, as measured by GDP, is growing again, most American households are still feeling the pain of a very weak labor market which all economists expect will be unusually slow to recover this time around.  Hence, the extension of unemployment benefits is easy to justify.

But what about the homebuyer tax credit–which in the original stimulus bill was set to expire on November 30?  Policymakers can argue that the housing market has been slow to recover as well–in large part due to the continued weakness in the labor market.  (Who feels like buying a new home when faced with so much job insecurity?)  But many economists are skeptical about whether this tax credit really “works” to give households the new incentive to go out and buy homes.  From the Post story:

Supporters of the tax credit, including the real estate industry, say it has energized home buyers and helped increase sales. But critics say the program is too expensive and has attracted mainly people who were going to buy a home anyway.

The Tax Policy Center’s Howard Gleckman recently blogged:

The early returns are coming in on the First-Time Homebuyer Tax Credit. And it appears to be a bigger boondoggle than even I thought it would be.

At a House Ways & Means Oversight subcommittee hearing today, the Internal Revenue Service inspector general reported that the IRS is auditing more than 100,000 of the roughly 1.4 million returns that included a claim for the credit. This is a staggering audit rate for an agency that usually reviews only about 1 percent of returns. 

And what the agency has found is jaw-dropping. Almost 74,000 buyers claimed the credit even though they probably owned a house over the past three years (the credit is only available to those who did not own during that period). One dead give-away: More than 12,000 of this bunch claimed the residential energy credit sometime during the past three years. Another 19,000 filed for the homebuyer credit even though they had not actually gotten around to buying a house, a fairly spectacular exhibition of chutzpah. And 580 credits were claimed on behalf of children, including at least one four-year-old—obviously a budding real estate developer…

Add to all of this the estimate by Ted Gayer at Brookings that more than 85 percent of the projected 2 million people expected to claim the credit would have bought a house anyway…

Then Howard notes how this makes the homebuyer tax credit similar to the Cash for Clunkers program:  it borrows money to move forward purchases that for the most part would have occurred (just a little later) anyway.

That the tax cut or subsidy (a rebate in the Clunkers case) designed to promote a certain form of economic activity doesn’t actually encourage that activity, makes many economists consider it “a waste”–a low economic “bang for the buck” policy.   But economists perhaps have too high standards, and how high or low the “bang” is depends on how one defines the “bang.”  And thinking more broadly and less “snootily” about what this policy is supposed to do, I realize that in the context of countercyclical “stimulus” intended to boost GDP during a downturn in the economy, there are many ways in which the homebuyer tax credit–like the Cash for Clunkers program–could still have a pretty big “bang” and “succeed” in a sense, even if it doesn’t actually encourage anyone to buy a home they wouldn’t have eventually bought anyway.

I see three possible effects of the tax credit on a household who claims it:

  1. The household buys exactly the same house exactly when they would have bought it anyway, so that the tax credit is like “free money”–extra cash they receive without having to change their homebuying behavior at all.
  2. The household buys the same kind of house they had been planning on buying later in the year, sooner.  The cash offer gets them to change thetiming of their homebuying behavior.
  3. The household buys a house when they weren’t even planning on buying a house, or they buy a bigger house than they were planning on buying.  The tax credit actually gets them to increase their quantity of housing demanded, more fundamentally affecting their homebuying behavior.

Case #3 is the only one that economists might label a “success” from a microeconomic, allocation of resources perspective; it’s the only case that in the longer run increases the quantity of housing consumed in the economy.  (And anyway, from an economist’s perspective we already heavily subsidize and over-consume housing, so if the goal is efficiency in the allocation of capital and notencouraging the “socially upstanding” behavior that supposedly comes with homeownership, even case #3 represents misguided policy.)  But all three cases could be quite successful from a macroeconomic stimulus perspective–that is, in quickly (even if just temporarily) boosting aggregate demand for goods and services.  Think GDP = C + I + G + (X-M) as I did in this post from earlier this yearwhen the “recovery and reinvestment” act passed, and recognize that even under case #1 where the tax credit is just a windfall of cash to the household, that such windfalls are often a reliable stimulus strategy as long as households spend most of those windfalls–even if not on a house but on other things.  And in case #2, that is exactly what distinguishes shorter-term policies to “stimulate” the economy from longer-term policies to encourage economic growth; in the former case, we’re merely moving forward or “smoothing” the economic activity, notpermanently increasing it.  (That’s what explains and justifies the government’sdeficit financing of the stimulus spending, too.)

From a stimulus perspective, it just boils down to who is getting the cash from the tax credit and will they spend most of the extra cash quickly?  Just like Cash for Clunkers didn’t necessarily permanently increase demand for automobiles but probably encouraged some car buyers to speed up their purchases and gave other car buyers extra cash to spend on other things like groceries, the homebuyer tax credit might just be another mechanism to direct cash into the economy in such a way that it gets quickly and effectively spent and translated into higher GDP.

So (snooty?) economists may choose to label the homebuyer tax credit a “waste” if it doesn’t fundamentally change homebuying behavior (or even changes it in the wrong direction), and I am certainly not apologizing for the poor quality of this policy as “housing” or “homeownership” policy.  But on the other hand in the context of macroeconomic stimulus, it is at least one way to direct “assistance” to a certain kind of household–young households buying first homes or (in this new version) just moving to a next home.  Perhaps we can think of it as steering the aid to growing families, which might partially offset the bias that the federal government tends to show toward seniors?  It’s like how I recognized that Cash for Clunkers might not create permanently higher demand for Detroit’s autos (or permanently sustain Detroit’s auto industry), yet I was still happy to reward those Americans who were at least temporarily (even if unintentionally) helping Detroit out.

–Cross posted from

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