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Access and Affordability
Access and Affordability: Homeowner Taxation SC Bourassa, University of Louisville, Louisville, KY, USA ª 2012 Elsevier Ltd. All rights reserved.
Glossary Capital gain The increase in the value of a home between sales, adjusted for the cost of capital improvements. Capital gains may be expressed in real (adjusted for general inflation) or nominal terms. Debt The portion of the cost of a home that is financed with a mortgage or other type of loan. Equity The portion of the cost of a home that is financed using the home owner’s own funds. Home ownership expense Home ownership expenses include various costs such as mortgage interest payments, hazard insurance, property taxes, maintenance, and condominium fees. They do not include
Types of Tax Expenditures National and other levels of government offer a variety of incentives to encourage home ownership. One impor tant class of incentives is tax expenditures, also referred to as tax preferences or tax concessions. Tax expendi tures are subsidies that are built into the income tax regulations, which are largely intended to reduce the cost of purchasing and occupying a home and thereby encourage owner-occupation. Tax expenditures can be in the form of deductions or credits for various expenses or exemption of certain types of income from taxation. There is considerable variation in the range and type of tax expenditures built into countries’ income tax regulations. Deductions and Credits Tax deductions reduce taxable income, while tax credits reduce the amount of tax due. Thus a given amount of tax credit is worth more than the same amount of tax deduc tion, because the latter must be multiplied by the taxpayer’s marginal tax rate to yield the tax savings. Tax deductions are more common than tax credits, and they typically apply to expenses such as mortgage interest payments or property taxes. Federal and some state gov ernments in the United States allow deduction of mortgage interest and property taxes, although there are various limits such as caps on the amount of interest that can be deducted. The United Kingdom used to allow deduction of mortgage interest, but this was gradually
POLICY
repayment of mortgage principal or the costs of capital improvements. Imputed rent The hypothetical rent that a homeowning household would pay to itself if it were treated in the income tax code as both a landlord and a tenant. Tax credit A reduction in the amount of income tax owed. Tax deduction A reduction in the amount of taxable income. Tax exemption An exclusion from taxation of a category of income that would otherwise be taxable. Tax expenditure A subsidy built into the income tax regulations in the form of a tax credit, deduction, or exemption.
phased out starting in the mid-1970s; it was completely eliminated by 2000. Switzerland allows deduction of mortgage interest and other housing expenses, although these deductions are offset by taxation of imputed rent. Countries such as Australia and New Zealand do not allow for any housing deductions or credits, and they exempt imputed rent and capital gains from taxation. Exemptions Tax exemptions or exclusions for owner-occupied housing include those for imputed rent and capital gains. Taxation of imputed (or implicit) rent involves treating home owners as if they were landlords by taxing an estimate of the rent that would be paid to occupy the dwelling while typically allowing deduction of at least some expenses. The logic behind this idea is that it provides a means for making the tax treatment of owner-occupied housing more like that of other capital investments, such as rental housing, thus resulting in a more efficient allocation of resources across different types of assets. On the negative side, taxing imputed rent adds complexity to the income tax system and is likely to be politically unpopular, particularly in coun tries where a majority of households are home owners. Introduction of an imputed rent tax may also have an inequitable effect on some households, particularly elderly home owners with reduced incomes and relatively small deductible expenses (because they no longer have a mortgage). Moreover, many countries have a policy of encouraging investment in owner-occupied housing and
13
14
Access and Affordability: Homeowner Taxation
are not particularly concerned with equalising investment incentives across assets. Switzerland, which has the lowest home ownership rate in the developed world (about 34%), is one of the few countries to tax imputed rent. With a wellestablished majority of renters, there is little political support for policies that encourage ownership. Nevertheless, imputed rent is calculated using rela tively conservative assumptions (the Swiss federal authorities aim to capture an imputed rent that is no less than 70% of market rent) and on average is less than the offsetting deductible expenses, which include mortgage interest, property taxes, maintenance, insur ance, and condominium fees. Capital gains are also commonly exempt, or at least partially exempt, from income taxation. Also, capital gains may be subject to tax rates that are less than those applicable to other income such as salaries and wages. One of the issues with capital gains is that in their optimal form they are difficult to administer. Ideally, only real (inflation-adjusted) gains would be added to income and taxed and real losses would be deducted. Gains or losses would be taxed or deducted as they accrue. The somewhat complex translation from nominal to real terms is further complicated by the need to adjust for the amount and timing of any capital improvements. As a consequence of these complications, countries may choose to tax only nominal gains, but at favourable rates (relative to other income). Moreover, home owners often sell one house in order to buy another and not infrequently this is due to a change in employment. Capital gains taxes thus could interfere with labour mobility. These and other considerations lead most countries to exempt all or most capital gains on owner-occupied homes from income taxation. Examples of countries that exempt owner-occupiers’ capital gains include Australia and New Zealand, where they are completely exempt, and the United States, where they are mostly exempt. In the United States, single persons or couples can exclude $250 000 or $500 000 in nominal gains per transaction, subject to some restrictions including a minimum occupancy period. In contrast, capi tal gains are taxed relatively heavily in Switzerland, where applicable tax rates have an inverse relationship with the holding period and, in at least some cantons, increase with the magnitude of the capital gains. The relationship between tax rates and the holding period is evidently intended to discourage speculative behaviour. In the canton of Geneva, for example, the capital gains tax rate is 50% if the property is resold within 2 years, and there is no tax if the property is sold after 25 years. However, in all cantons, the tax is postponed if the pro ceeds are used to purchase another home (subject to some restrictions).
Policy Considerations Some of the policy questions regarding tax expenditures for owner-occupied housing have been touched on in the preceding paragraphs. Broadly speaking, there are two main sets of issues that need to be addressed. The first question concerns whether home ownership should be subsidised. If the answer to this first question is affirma tive, then the second question arises concerning the choice between tax expenditures and other forms of sub sidy, such as direct grants or income supplements.
Should Home Ownership be Subsidised? Various public and private benefits have been attributed to home ownership. The public benefits include greater involvement in and commitment to the community on the part of home-owning households, better upkeep of homes, and improved children’s outcomes, such as higher high school graduation rates and lower pregnancy rates among teenagers. Although empirical analyses have attempted to control for it, there remains a question about whether most or all of these benefits are due to the greater stability associated with home ownership. In a country such as Switzerland, with a tradition of long-term rental tenancy, the relationship between these benefits and home owner ship may be less pronounced or nonexistent. Private benefits include the ability to accumulate wealth and to have more control over interior and exterior decoration. Costs associated with government support of home ownership include the costs of the subsidies (i.e., the fore gone revenues), which are not negligible. For example, the mortgage interest deduction in the United States is the second largest tax expenditure in that country (after the deductibility of health insurance premiums paid by employers). The revenue gain is actually somewhat less than the official figures, because eliminating the deduct ibility of mortgage interest would cause buyers to shift from debt to equity financing, and since income from alternative investments of that equity would presumably be taxed there is a partial offsetting revenue loss. Another cost is associated with reductions in labor mobility, parti cularly in declining markets where houses may be difficult to sell. This is clearly a problem in many markets today in the United States and other countries. It is also evident that home ownership is not sustainable for many households. In more than a few markets, home ownership has proven to be a bad investment. Finally, subsidies for home ownership may lead to overinvestment in that sector at the expense of more productive uses of resources. On balance, it is difficult to make a strong case in support of subsidies for home ownership, given that there seem to be as many drawbacks as advantages. Moreover, even if home ownership does yield social
Access and Affordability: Homeowner Taxation
benefits, getting the policy just right would seem to be an impossible task. Nevertheless, home ownership seems firmly rooted in many national cultures, as evidenced by terms such as The American Dream, The Great Australian Dream, or The Great New Zealand Dream. Consequently, policies to subsidise home ownership con tinue to be supported regardless of their merits. In the United States, for example, the President’s Advisory Panel on Federal Tax Reform recommended in 2005 that the mortgage interest deduction be eliminated and replaced with a much more targeted tax credit. Even this relatively tepid policy proposal was strongly opposed by various housing industry groups. This and the other recommendations of the panel were quickly shelved.
15
Evidence on Their Impacts There is also a question about whether tax expenditures have desired policy impacts with respect to home owner ship. In the United States, for example, the mortgage interest deduction was introduced at a time when few households actually paid income tax and so it was clearly not intended to encourage home ownership to any sig nificant extent. Subsequently, however, a significant constituency has come to rely on the deduction and it has become politically impossible to change it substan tially. In the United Kingdom, the mortgage interest deduction was also quite popular, but it was phased out very gradually, so that by the time it was completely eliminated in 2000, it was not having much of an impact.
Tax Expenditures Versus Alternatives Tax expenditures are indirect subsidies in the sense that they reduce tax revenues and do not involve cash grants that must be budgeted and appropriated by governments. Alternatives to tax expenditures include direct subsidies in the form of grants to first-time buyers as have been used in Australia, for example. The US government pro vides funds to state and local governments that can be used as grants towards home purchase by households meeting certain income criteria. Sometimes these grants are in the form of soft second mortgages, which need not be repaid if the buyer remains in the home for a minimum period of time, such as 5 years. Another option is housing allowances, which are income supplements for lowincome households, including owner-occupiers. Housing allowances in New Zealand, for example, benefit lowincome households regardless of housing tenure. There are at least two broad policy concerns that speak against the use of tax expenditures. One is the issue of transparency. While direct subsidies must periodically be reviewed and approved by governments, once tax expen ditures are included in the income tax regulations, they no longer need to be addressed explicitly in any budget ing process. Consequently, they are relatively hidden compared to direct subsidies. Regressive subsidies, such as the mortgage interest deduction in the United States, survive in the form of a tax expenditure, but would be highly unlikely to be supported in the form of a direct subsidy. The other issue concerns tax simplification. This is particularly an issue in the United States, where the individual income tax code has become increasingly com plex over time, and compliance requires the expenditure of considerable resources on the part of individuals and government. Tax credits and deductions in the code make compliance more costly. In contrast, New Zealand has greatly simplified its income tax code, to the point that many individuals no longer need to file any paperwork. Obviously, tax expenditures cannot play a role if the aim is to simplify the tax rules.
Mortgage Interest Deduction Most of the research on the impacts of the mortgage interest deduction has focussed on the United States. The impact of the deduction in the United States is somewhat blunted by the fact that some home buyers, particularly those with lower incomes, cannot take advan tage of it because their total deductions do not meet certain threshholds. Consequently, they take a standard deduction rather than itemised deductions and the mort gage interest deduction is effectively wasted. Many of the individuals and households who receive the most benefit from the deduction do not really need it as they would be able to afford home ownership in any case. For these households, the deduction is probably just helping to subsidise the purchase of larger homes. Moreover, much of the value of the deduction appears to be capitalised into land prices, meaning that houses are more costly than they otherwise would be. This is particularly an issue for first-time buyers, for whom any savings provided by the deduction may be offset by higher prices. Recent empirical research on housing tenure choice in US metropolitan areas suggests that for young adults the impacts of the deductions on house prices may well offset the savings in taxes. Moreover, a more targeted tax credit – such as that proposed by the President’s Advisory Panel on Federal Tax Reform – also would not encourage home ownership on average, although it would change the geography of housing tenure somewhat by raising ownership rates in expensive locations and lowering them in less costly places. On balance, it seems that neither tax deductions nor tax credits for mortgage interest are effective in encouraging home ownership. Some policy analysts have defended the mortgage interest deduction on the grounds that it equalises the after-tax cost of debt and equity financing and that the real tax expenditure is the failure to tax imputed rent. At least two Nobel laureates in economics (Herbert Simon
16
Access and Affordability: Homeowner Taxation
and William Vickrey) have advocated taxation of imputed rent for this reason. Imputed Rent The main policy objective of taxing imputed rent is to attempt to equalise the cost of investing in owneroccupied housing with the costs of investing in other capital assets. Nevertheless, much of the policy discussion has focussed on the impacts on ownership rates of taxing imputed rent and on the distribution of the income tax burden across different income groups. Recent research on Switzerland has considered the impacts of a range of factors on housing tenure in an attempt to explain the country’s extraordinarily low own ership rate. While high prices appear to have the biggest impact on tenure choice, the second most important fac tor is the tax on imputed rent, which is estimated to reduce the ownership rate by 9 percentage points. However, if the related deductions (mortgage interest and so forth) were also removed, then the ownership rate would drop slightly, due to the fact that the deduc tions are typically worth more than the conservatively estimated imputed rent. It is probably inappropriate to extrapolate this finding to other countries where circum stances are quite different. Empirical research in Australia has explored the dis tributional effects of a hypothetical tax on imputed rent on different income and age groups. The main findings are that the tax burden does not fall more heavily on lowincome households when net imputed rent (i.e., net of deductible expenses) is included in owners’ incomes and life cycle effects are controlled for. Nevertheless, this does not really overcome the practical problem that would be faced by those low-income, particularly elderly, house holds who are house-rich and income-poor.
Policy Implications This overview has been based primarily on the experi ences of a small number of countries, specifically Australia, New Zealand, Switzerland, the United Kingdom, and the United States. Nevertheless, these cases suggest some gen eral policy conclusions that may be relevant elsewhere. One conclusion is that it is impossible to satisfy all possible policy objectives. For example, one policy objec tive is efficiency in resource allocation. If it is assumed that home ownership does provide social benefits, then the goal of efficiency might justify subsidies to increase the ownership rate. If home ownership is not the source of social benefits, then efficiency is achieved by equalising costs across different assets to avoid overinvestment in owner-occupied housing. In this case it would be desir able to fully tax imputed rent and real capital gains,
allowing deductions for expenses and real losses. But it is difficult to accurately measure imputed rent and real gains and losses, leading to significant administrative and compliance issues. Switzerland adopts a second-best approach to this by taxing a very conservative and rough estimate of imputed rent and nominal, rather than real, capital gains. The United States, in contrast, does not bother with trying to tax imputed rent (it does not even consider imputed rent to be a form of income) and exempts most capital gains from taxation. The capital gains that are taxed are nominal, rather than real. But the US tax code retains two significant deductible expenses – mortgage interest and property taxes – which, from an efficiency point of view, probably does not make sense given that the relevant income (imputed rent) remains untaxed. Moreover, it is unclear that these deduc tions have the positive impact on home ownership attributed to them. Instead their effects seem to be higher land prices and consumption of larger homes by house holds who do not need subsidies to afford home ownership. Consequently, there appears to be a strong argument for eliminating deductions if imputed rent is not taxed. The goals of tax simplification and transparency also strongly suggest that these deductions should be eliminated. This does not mean that governments desiring to encourage home ownership are left without any tools. Australia has successfully used grants for first-time home buyers to encourage home ownership. There is, however, some evidence to suggest that these grants merely speed up access to ownership for households who would eventually become home owners in any case. If encouraging home ownership is not a policy objective, there are subsidies that may be attractive for other reasons. New Zealand’s housing allowances are available to both renters and owners (and therefore do not introduce any tenure bias) and may be particularly helpful in avoiding foreclosure in the case of households whose income has been reduced due to job loss, illness, or retirement. Such allowances could be particu larly helpful in avoiding both household distress and housing market disruptions in times of recession. See also: Access and Affordability: Housing Allowances; First Home Owner Grants; Home Ownership: Economic Benefits; Low-Income Housing Tax Credits; Taxation Policy and Housing.
Further Reading Bourassa SC, Greig AW, and Troy PN (1995) The limits of housing policy: Home ownership in Australia. Housing Studies 10: 83–103. Bourassa SC and Grigsby WG (2000) Income tax concessions for owner-occupied housing. Housing Policy Debate 11: 521–546. Bourassa SC and Hendershott PH (1994) On the equity effects of taxing imputed rent: Evidence from Australia. Housing Policy Debate 5: 73–95. Bourassa SC and Hoesli M (2010) Why do the Swiss rent? Journal of Real Estate Finance and Economics, 40: 296–309.
Access and Affordability: Homeowner Taxation Bourassa SC and Yin M (2006) Housing tenure choice in Australia and the United States: Impacts of alternative subsidy policies. Real Estate Economics 34: 303–328. Bourassa SC and Yin M (2008) Tax deductions, tax credits, and the home ownership rate of young urban adults in the United States. Urban Studies 45: 1141–1161. Capozza D, Green R, and Hendershott PH (1996) Taxes, mortgage borrowing, and residential land prices. In: Aaron HJ and Gale WG (eds.) Effects of Fundamental Tax Reform, pp. 171–210. Washington, DC: Brookings Institution. Follain JR, Ling DC and McGill GA (1993) The preferential tax treatment of owner-occupied housing: Who really benefits? Housing Policy Debate 4: 1–24. Follain JR and Melamed LS (1998) The false messiah of tax policy: What elimination of the home mortgage interest deduction promises and a careful look at what it delivers. Journal of Housing Research 9: 179–199.
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Goode R (1960) Imputed rent of owner-occupied dwellings under the income tax. Journal of Finance 15: 504–530. Green RK and Vandell KD (1999) Giving households credit: How changes in the U.S. tax code could promote homeownership. Regional Science and Urban Economics 29: 419–444. Hendershott PH and White M (2000) The rise and fall of housing’s favored investment status. Journal of Housing Research 11: 257–275. Laidler D (1969) Income tax incentives for owner-occupied housing. In: Harberger AC and Bailey MJ (eds.) Taxation of Income from Capital, pp. 50–76. Washington, DC: Brookings Institution. Rohe WM and Watson HL (eds.) (2007). Chasing the American Dream: New Perspectives on Affordable Homeownership. Ithaca, NY: Cornell University Press. Woodward SE and Weicher JC (1989) Goring the wrong ox: A defense of the mortgage interest deduction. National Tax Journal 42: 301–313.
Glossary Capital gain The increase in the value of a home between sales, adjusted for the cost of capital improvements. Capital gains may be expressed in real (adjusted for general inflation) or nominal terms. Debt The portion of the cost of a home that is financed with a mortgage or other type of loan. Equity The portion of the cost of a home that is financed using the home owner’s own funds. Home ownership expense Home ownership expenses include various costs such as mortgage interest payments, hazard insurance, property taxes, maintenance, and condominium fees. They do not include
Types of Tax Expenditures National and other levels of government offer a variety of incentives to encourage home ownership. One impor tant class of incentives is tax expenditures, also referred to as tax preferences or tax concessions. Tax expendi tures are subsidies that are built into the income tax regulations, which are largely intended to reduce the cost of purchasing and occupying a home and thereby encourage owner-occupation. Tax expenditures can be in the form of deductions or credits for various expenses or exemption of certain types of income from taxation. There is considerable variation in the range and type of tax expenditures built into countries’ income tax regulations. Deductions and Credits Tax deductions reduce taxable income, while tax credits reduce the amount of tax due. Thus a given amount of tax credit is worth more than the same amount of tax deduc tion, because the latter must be multiplied by the taxpayer’s marginal tax rate to yield the tax savings. Tax deductions are more common than tax credits, and they typically apply to expenses such as mortgage interest payments or property taxes. Federal and some state gov ernments in the United States allow deduction of mortgage interest and property taxes, although there are various limits such as caps on the amount of interest that can be deducted. The United Kingdom used to allow deduction of mortgage interest, but this was gradually
POLICY
repayment of mortgage principal or the costs of capital improvements. Imputed rent The hypothetical rent that a homeowning household would pay to itself if it were treated in the income tax code as both a landlord and a tenant. Tax credit A reduction in the amount of income tax owed. Tax deduction A reduction in the amount of taxable income. Tax exemption An exclusion from taxation of a category of income that would otherwise be taxable. Tax expenditure A subsidy built into the income tax regulations in the form of a tax credit, deduction, or exemption.
phased out starting in the mid-1970s; it was completely eliminated by 2000. Switzerland allows deduction of mortgage interest and other housing expenses, although these deductions are offset by taxation of imputed rent. Countries such as Australia and New Zealand do not allow for any housing deductions or credits, and they exempt imputed rent and capital gains from taxation. Exemptions Tax exemptions or exclusions for owner-occupied housing include those for imputed rent and capital gains. Taxation of imputed (or implicit) rent involves treating home owners as if they were landlords by taxing an estimate of the rent that would be paid to occupy the dwelling while typically allowing deduction of at least some expenses. The logic behind this idea is that it provides a means for making the tax treatment of owner-occupied housing more like that of other capital investments, such as rental housing, thus resulting in a more efficient allocation of resources across different types of assets. On the negative side, taxing imputed rent adds complexity to the income tax system and is likely to be politically unpopular, particularly in coun tries where a majority of households are home owners. Introduction of an imputed rent tax may also have an inequitable effect on some households, particularly elderly home owners with reduced incomes and relatively small deductible expenses (because they no longer have a mortgage). Moreover, many countries have a policy of encouraging investment in owner-occupied housing and
13
14
Access and Affordability: Homeowner Taxation
are not particularly concerned with equalising investment incentives across assets. Switzerland, which has the lowest home ownership rate in the developed world (about 34%), is one of the few countries to tax imputed rent. With a wellestablished majority of renters, there is little political support for policies that encourage ownership. Nevertheless, imputed rent is calculated using rela tively conservative assumptions (the Swiss federal authorities aim to capture an imputed rent that is no less than 70% of market rent) and on average is less than the offsetting deductible expenses, which include mortgage interest, property taxes, maintenance, insur ance, and condominium fees. Capital gains are also commonly exempt, or at least partially exempt, from income taxation. Also, capital gains may be subject to tax rates that are less than those applicable to other income such as salaries and wages. One of the issues with capital gains is that in their optimal form they are difficult to administer. Ideally, only real (inflation-adjusted) gains would be added to income and taxed and real losses would be deducted. Gains or losses would be taxed or deducted as they accrue. The somewhat complex translation from nominal to real terms is further complicated by the need to adjust for the amount and timing of any capital improvements. As a consequence of these complications, countries may choose to tax only nominal gains, but at favourable rates (relative to other income). Moreover, home owners often sell one house in order to buy another and not infrequently this is due to a change in employment. Capital gains taxes thus could interfere with labour mobility. These and other considerations lead most countries to exempt all or most capital gains on owner-occupied homes from income taxation. Examples of countries that exempt owner-occupiers’ capital gains include Australia and New Zealand, where they are completely exempt, and the United States, where they are mostly exempt. In the United States, single persons or couples can exclude $250 000 or $500 000 in nominal gains per transaction, subject to some restrictions including a minimum occupancy period. In contrast, capi tal gains are taxed relatively heavily in Switzerland, where applicable tax rates have an inverse relationship with the holding period and, in at least some cantons, increase with the magnitude of the capital gains. The relationship between tax rates and the holding period is evidently intended to discourage speculative behaviour. In the canton of Geneva, for example, the capital gains tax rate is 50% if the property is resold within 2 years, and there is no tax if the property is sold after 25 years. However, in all cantons, the tax is postponed if the pro ceeds are used to purchase another home (subject to some restrictions).
Policy Considerations Some of the policy questions regarding tax expenditures for owner-occupied housing have been touched on in the preceding paragraphs. Broadly speaking, there are two main sets of issues that need to be addressed. The first question concerns whether home ownership should be subsidised. If the answer to this first question is affirma tive, then the second question arises concerning the choice between tax expenditures and other forms of sub sidy, such as direct grants or income supplements.
Should Home Ownership be Subsidised? Various public and private benefits have been attributed to home ownership. The public benefits include greater involvement in and commitment to the community on the part of home-owning households, better upkeep of homes, and improved children’s outcomes, such as higher high school graduation rates and lower pregnancy rates among teenagers. Although empirical analyses have attempted to control for it, there remains a question about whether most or all of these benefits are due to the greater stability associated with home ownership. In a country such as Switzerland, with a tradition of long-term rental tenancy, the relationship between these benefits and home owner ship may be less pronounced or nonexistent. Private benefits include the ability to accumulate wealth and to have more control over interior and exterior decoration. Costs associated with government support of home ownership include the costs of the subsidies (i.e., the fore gone revenues), which are not negligible. For example, the mortgage interest deduction in the United States is the second largest tax expenditure in that country (after the deductibility of health insurance premiums paid by employers). The revenue gain is actually somewhat less than the official figures, because eliminating the deduct ibility of mortgage interest would cause buyers to shift from debt to equity financing, and since income from alternative investments of that equity would presumably be taxed there is a partial offsetting revenue loss. Another cost is associated with reductions in labor mobility, parti cularly in declining markets where houses may be difficult to sell. This is clearly a problem in many markets today in the United States and other countries. It is also evident that home ownership is not sustainable for many households. In more than a few markets, home ownership has proven to be a bad investment. Finally, subsidies for home ownership may lead to overinvestment in that sector at the expense of more productive uses of resources. On balance, it is difficult to make a strong case in support of subsidies for home ownership, given that there seem to be as many drawbacks as advantages. Moreover, even if home ownership does yield social
Access and Affordability: Homeowner Taxation
benefits, getting the policy just right would seem to be an impossible task. Nevertheless, home ownership seems firmly rooted in many national cultures, as evidenced by terms such as The American Dream, The Great Australian Dream, or The Great New Zealand Dream. Consequently, policies to subsidise home ownership con tinue to be supported regardless of their merits. In the United States, for example, the President’s Advisory Panel on Federal Tax Reform recommended in 2005 that the mortgage interest deduction be eliminated and replaced with a much more targeted tax credit. Even this relatively tepid policy proposal was strongly opposed by various housing industry groups. This and the other recommendations of the panel were quickly shelved.
15
Evidence on Their Impacts There is also a question about whether tax expenditures have desired policy impacts with respect to home owner ship. In the United States, for example, the mortgage interest deduction was introduced at a time when few households actually paid income tax and so it was clearly not intended to encourage home ownership to any sig nificant extent. Subsequently, however, a significant constituency has come to rely on the deduction and it has become politically impossible to change it substan tially. In the United Kingdom, the mortgage interest deduction was also quite popular, but it was phased out very gradually, so that by the time it was completely eliminated in 2000, it was not having much of an impact.
Tax Expenditures Versus Alternatives Tax expenditures are indirect subsidies in the sense that they reduce tax revenues and do not involve cash grants that must be budgeted and appropriated by governments. Alternatives to tax expenditures include direct subsidies in the form of grants to first-time buyers as have been used in Australia, for example. The US government pro vides funds to state and local governments that can be used as grants towards home purchase by households meeting certain income criteria. Sometimes these grants are in the form of soft second mortgages, which need not be repaid if the buyer remains in the home for a minimum period of time, such as 5 years. Another option is housing allowances, which are income supplements for lowincome households, including owner-occupiers. Housing allowances in New Zealand, for example, benefit lowincome households regardless of housing tenure. There are at least two broad policy concerns that speak against the use of tax expenditures. One is the issue of transparency. While direct subsidies must periodically be reviewed and approved by governments, once tax expen ditures are included in the income tax regulations, they no longer need to be addressed explicitly in any budget ing process. Consequently, they are relatively hidden compared to direct subsidies. Regressive subsidies, such as the mortgage interest deduction in the United States, survive in the form of a tax expenditure, but would be highly unlikely to be supported in the form of a direct subsidy. The other issue concerns tax simplification. This is particularly an issue in the United States, where the individual income tax code has become increasingly com plex over time, and compliance requires the expenditure of considerable resources on the part of individuals and government. Tax credits and deductions in the code make compliance more costly. In contrast, New Zealand has greatly simplified its income tax code, to the point that many individuals no longer need to file any paperwork. Obviously, tax expenditures cannot play a role if the aim is to simplify the tax rules.
Mortgage Interest Deduction Most of the research on the impacts of the mortgage interest deduction has focussed on the United States. The impact of the deduction in the United States is somewhat blunted by the fact that some home buyers, particularly those with lower incomes, cannot take advan tage of it because their total deductions do not meet certain threshholds. Consequently, they take a standard deduction rather than itemised deductions and the mort gage interest deduction is effectively wasted. Many of the individuals and households who receive the most benefit from the deduction do not really need it as they would be able to afford home ownership in any case. For these households, the deduction is probably just helping to subsidise the purchase of larger homes. Moreover, much of the value of the deduction appears to be capitalised into land prices, meaning that houses are more costly than they otherwise would be. This is particularly an issue for first-time buyers, for whom any savings provided by the deduction may be offset by higher prices. Recent empirical research on housing tenure choice in US metropolitan areas suggests that for young adults the impacts of the deductions on house prices may well offset the savings in taxes. Moreover, a more targeted tax credit – such as that proposed by the President’s Advisory Panel on Federal Tax Reform – also would not encourage home ownership on average, although it would change the geography of housing tenure somewhat by raising ownership rates in expensive locations and lowering them in less costly places. On balance, it seems that neither tax deductions nor tax credits for mortgage interest are effective in encouraging home ownership. Some policy analysts have defended the mortgage interest deduction on the grounds that it equalises the after-tax cost of debt and equity financing and that the real tax expenditure is the failure to tax imputed rent. At least two Nobel laureates in economics (Herbert Simon
16
Access and Affordability: Homeowner Taxation
and William Vickrey) have advocated taxation of imputed rent for this reason. Imputed Rent The main policy objective of taxing imputed rent is to attempt to equalise the cost of investing in owneroccupied housing with the costs of investing in other capital assets. Nevertheless, much of the policy discussion has focussed on the impacts on ownership rates of taxing imputed rent and on the distribution of the income tax burden across different income groups. Recent research on Switzerland has considered the impacts of a range of factors on housing tenure in an attempt to explain the country’s extraordinarily low own ership rate. While high prices appear to have the biggest impact on tenure choice, the second most important fac tor is the tax on imputed rent, which is estimated to reduce the ownership rate by 9 percentage points. However, if the related deductions (mortgage interest and so forth) were also removed, then the ownership rate would drop slightly, due to the fact that the deduc tions are typically worth more than the conservatively estimated imputed rent. It is probably inappropriate to extrapolate this finding to other countries where circum stances are quite different. Empirical research in Australia has explored the dis tributional effects of a hypothetical tax on imputed rent on different income and age groups. The main findings are that the tax burden does not fall more heavily on lowincome households when net imputed rent (i.e., net of deductible expenses) is included in owners’ incomes and life cycle effects are controlled for. Nevertheless, this does not really overcome the practical problem that would be faced by those low-income, particularly elderly, house holds who are house-rich and income-poor.
Policy Implications This overview has been based primarily on the experi ences of a small number of countries, specifically Australia, New Zealand, Switzerland, the United Kingdom, and the United States. Nevertheless, these cases suggest some gen eral policy conclusions that may be relevant elsewhere. One conclusion is that it is impossible to satisfy all possible policy objectives. For example, one policy objec tive is efficiency in resource allocation. If it is assumed that home ownership does provide social benefits, then the goal of efficiency might justify subsidies to increase the ownership rate. If home ownership is not the source of social benefits, then efficiency is achieved by equalising costs across different assets to avoid overinvestment in owner-occupied housing. In this case it would be desir able to fully tax imputed rent and real capital gains,
allowing deductions for expenses and real losses. But it is difficult to accurately measure imputed rent and real gains and losses, leading to significant administrative and compliance issues. Switzerland adopts a second-best approach to this by taxing a very conservative and rough estimate of imputed rent and nominal, rather than real, capital gains. The United States, in contrast, does not bother with trying to tax imputed rent (it does not even consider imputed rent to be a form of income) and exempts most capital gains from taxation. The capital gains that are taxed are nominal, rather than real. But the US tax code retains two significant deductible expenses – mortgage interest and property taxes – which, from an efficiency point of view, probably does not make sense given that the relevant income (imputed rent) remains untaxed. Moreover, it is unclear that these deduc tions have the positive impact on home ownership attributed to them. Instead their effects seem to be higher land prices and consumption of larger homes by house holds who do not need subsidies to afford home ownership. Consequently, there appears to be a strong argument for eliminating deductions if imputed rent is not taxed. The goals of tax simplification and transparency also strongly suggest that these deductions should be eliminated. This does not mean that governments desiring to encourage home ownership are left without any tools. Australia has successfully used grants for first-time home buyers to encourage home ownership. There is, however, some evidence to suggest that these grants merely speed up access to ownership for households who would eventually become home owners in any case. If encouraging home ownership is not a policy objective, there are subsidies that may be attractive for other reasons. New Zealand’s housing allowances are available to both renters and owners (and therefore do not introduce any tenure bias) and may be particularly helpful in avoiding foreclosure in the case of households whose income has been reduced due to job loss, illness, or retirement. Such allowances could be particu larly helpful in avoiding both household distress and housing market disruptions in times of recession. See also: Access and Affordability: Housing Allowances; First Home Owner Grants; Home Ownership: Economic Benefits; Low-Income Housing Tax Credits; Taxation Policy and Housing.
Further Reading Bourassa SC, Greig AW, and Troy PN (1995) The limits of housing policy: Home ownership in Australia. Housing Studies 10: 83–103. Bourassa SC and Grigsby WG (2000) Income tax concessions for owner-occupied housing. Housing Policy Debate 11: 521–546. Bourassa SC and Hendershott PH (1994) On the equity effects of taxing imputed rent: Evidence from Australia. Housing Policy Debate 5: 73–95. Bourassa SC and Hoesli M (2010) Why do the Swiss rent? Journal of Real Estate Finance and Economics, 40: 296–309.
Access and Affordability: Homeowner Taxation Bourassa SC and Yin M (2006) Housing tenure choice in Australia and the United States: Impacts of alternative subsidy policies. Real Estate Economics 34: 303–328. Bourassa SC and Yin M (2008) Tax deductions, tax credits, and the home ownership rate of young urban adults in the United States. Urban Studies 45: 1141–1161. Capozza D, Green R, and Hendershott PH (1996) Taxes, mortgage borrowing, and residential land prices. In: Aaron HJ and Gale WG (eds.) Effects of Fundamental Tax Reform, pp. 171–210. Washington, DC: Brookings Institution. Follain JR, Ling DC and McGill GA (1993) The preferential tax treatment of owner-occupied housing: Who really benefits? Housing Policy Debate 4: 1–24. Follain JR and Melamed LS (1998) The false messiah of tax policy: What elimination of the home mortgage interest deduction promises and a careful look at what it delivers. Journal of Housing Research 9: 179–199.
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Goode R (1960) Imputed rent of owner-occupied dwellings under the income tax. Journal of Finance 15: 504–530. Green RK and Vandell KD (1999) Giving households credit: How changes in the U.S. tax code could promote homeownership. Regional Science and Urban Economics 29: 419–444. Hendershott PH and White M (2000) The rise and fall of housing’s favored investment status. Journal of Housing Research 11: 257–275. Laidler D (1969) Income tax incentives for owner-occupied housing. In: Harberger AC and Bailey MJ (eds.) Taxation of Income from Capital, pp. 50–76. Washington, DC: Brookings Institution. Rohe WM and Watson HL (eds.) (2007). Chasing the American Dream: New Perspectives on Affordable Homeownership. Ithaca, NY: Cornell University Press. Woodward SE and Weicher JC (1989) Goring the wrong ox: A defense of the mortgage interest deduction. National Tax Journal 42: 301–313.