Tax Policy and the Purpose of a House

As much as possible, the tax code shouldn’t bias investment decisions. As it is, the tax code is too heavily weighted in favor of housing… Congress should level the investment playing field by treating capital gains on real estate, stocks, bonds and other assets the same… Doing so would also reduce the incentive for speculative investment in real estate and remove some disincentive to investing in the stock market. My guess is that investors would shift more of their money into Corporate America, especially innovative companies that create the wealth of the future (p. 214).

Upon the initial reading of my economics textbook, the above passage first convinced me that I might have something to say in response to the BusinessWeek perspective on the world. The article complained that the Taxpayer Relief Act of 1997, by eliminating capital gains taxes on real estate profits (under certain circumstances), promoted speculation within the housing market and lead to unsustainable gains in housing costs, which have now lead to a whole host of other economic troubles. This seems to me an extremely narrow vision of the world. First of all, this article ignores the large proportion of the American populace who don’t have any spare wealth to invest in real estate or any other form of investment. Then there’s the even larger proportion of the American populace whose home is their only investment. I would imagine, although I can’t say that I’ve ever spoken with him about this personally, that Bill Clinton was aiming the tax code much more at that middle class voting block than at the small percentage of folks making a fortune from real estate flipping. If that’s the case, then the merits of the Taxpayer Act can certainly be debated, but they must be debated by considering a much wider sphere of influence and possible consequences. People don’t just buy houses to resell them. They buy them to live in, because human beings need shelter. Obvious stuff, but it leads to a different set of questions when evaluating housing policy. Did the tax benefits increase the stock of homes? How about the affordability of those homes? Did it allow people to move up to a better house than they might otherwise have been able to afford, leaving their previous residence available for someone else? Did it create jobs for homebuilders? And, to be fair, how did it affect the likelihood of speculation and price inflation within the housing market?

Then, once we have resettled our perspective to realize that most homeowners who may have benefited from the tax policy were not speculators trying to merely cash in on a profitable investment, we have to ask how much influence was truly wielded by the few who were. Although I do find it plausible that certain investors may have made some clear calculations and decided to invest in real estate due to the particulars of this bit of tax policy, I find it quite implausible that these people could have had such a profound impact. Could those few speculators have really set off the forest fire that swept through the housing market? Or was it more like a thousand campfires of individual homeowners hoping to get in on the heat?

And that leads me to the issue of the susceptibility of any kind of investment market to bubbles and panics and all sorts of other changes in elevation that are much more fun on a roller coaster ride than they are in an economy. But I’ve already grumbled about just how fishy the whole stock market seems to me, so I suppose I’ll just let that rant go for today. I’ll just get back to reading tax code and plotting my next investment strategy.

Christopher Farrell. A Housing Boom Built on Folly. in Downey, Matthew. Contemporary’s Economics. Chicago: McGraw Hill Wright, 2007