How tax policy subsidizes homeownership, mostly for the wealthiest Americans

OK.  Imagine that someone offers you this investment deal.  We want you to buy some stock; in fact, we want you to buy about $150,000 or $200,000 in stock.  In a single company.  Sounds a bit risky, doesn’t it?  But keep listening, we have some special terms that make this a very attractive deal.

We have such a deal for you (unless you are a renter).

First, we’ll help you buy the stock “on margin”–you only need to come up with 10 or 20 percent of the purchase price of the stock.  We’ll lend you 80 or 90 percent of the cost of buying the stock. (And it will be a guaranteed, long term, low interest rate loan, with a fixed rate).  So right away, you’ve got leverage on your investment of five- or ten-fold, meaning that any increase in price of the stock multiplies your profits by a factor of five or ten.

Second, this is a special preferred stock that pays annual dividends of about 5 percent.  So your $200,000 investment pays about $10,000 per year in dividends.  And thanks to a special deal we’ve cut with the government, and unlike any other preferred stock, you get to take these dividends tax-free.

Third, of course, you had to borrow a bunch of money to buy this stock, but good news:  you can deduct the interest you pay on your loan from your taxable income.

Fourth, someday, when you sell your stock, you’ll have a capital gain, but again, we have yet another special deal with the government, so that you can exclude any capital gain you make on this stock from your taxable income.

It’s a great deal isn’t it?

So what is this fantasy stock?  It isn’t a stock, but it isn’t a fantasy either:  It’s owner-occupied housing in the US.

In fact, the higher the income, and the bigger the home you buy, the more you stand to profit from all of these special deals. The value of the mortgage interest deduction, exclusions of imputed rent, and deductibility of state and local taxes are all worth more to you if you are in a higher tax bracket. The mortgage interest deduction only has value if you earn enough to itemize deductions, meaning few low income homeowners can take advantage. It’s estimated that 90 percent of the value of the mortgage interest deduction goes to households with incomes of $100,000 or more. The higher the income and the more you spend on housing, the more your leveraged investment is worth, the more imputed rental income you shelter from taxes, the larger a capital gain you stand to earn.

One of the most important–and usually overlooked provisions of the tax code is the exclusion from taxation on imputed rental income. Here’s how this works.  If you rent your home from someone else, they have to pay income tax on the net income they get from renting. If you rent your home from yourself (i.e. you are a homeowner), you don’t have to pay income tax on that “income.” Your $200,000 home might rent for $1,500 a month, and if you are the owner and live there, you’re effectively getting a that amount of income (net of upkeep), tax free. That makes housing different from virtually every other investment because the dividends from housing (the ability to live rent free in a home you own) doesn’t get counted as taxable income.

You can even buy a second home and get the same deal.

Collectively, the value of these tax breaks for owner occupied housing constitute a subsidy of more than $250 billion per year from the federal government.

The irony here is that there’s almost no evidence that these tax provisions have actually increased homeownership. A new research paper by Jonathan Gruber and two colleagues shows that the deductibility of mortgage interest tends to increase the size of home that people purchase, but doesn’t influence whether they choose to be homeowners. Little wonder we have a nation of huge houses with tons of empty bedrooms.

Oh, and if you’re a renter, you’re probably asking, what kind of deal do we have for you? In short, no deal. Our advice is that you really ought to be a homeowner. But for lower income people, the path to homeownership is difficult and risky. As we’ve explained, low income buyers tend to buy at the wrong time (when the market is near a peak), pay more for credit, buy in more volatile neighborhoods and are more vulnerable in downturns. Its also the case that the the value of all of these tax code subsidies is smallest for low income households.

What we’ve done is to make homeownership a great deal . . . but only if you’ve got enough income to benefit from all the provisions the tax code offers.