Did the 1997 tax law change that allows home sellers to exclude hundreds of thousands of dollars from their taxable income contribute to today's economic crisis?
At the blog Cafe Hayek, economists have been examining the housing bubble and what role public policy might have had in the housing price increases and the subprime meltdown.
"Maybe it wasn't speculative mania," writes Russell Roberts. "Maybe much of it was due to changes in public policy."
A tax boon for home sellers: The specific policy change
For the last 12 years, homeowners have been able to avoid capital gains taxes on net home sale profits of $250,000 if they are single taxpayers and $500,000 if they sellers are married couples filing jointly.
The beauty of the current law is that to get this tax break you don't have to buy another home within a specific time frame, as the home-sale tax law demanded of most pre-1997 sellers. You just have to live in the property as your primary home for two of the five years before selling.
When the bubble was inflating, folks made small fortunes buying homes, living there for a few years and then selling for a nice, nontaxable profit. It was a literal cottage (or ranch or colonial) industry.
The financial sector quickly joined home buyers, sellers and the housing industry in taking advantage of the once quite lucrative real estate market.
Now many folks are stuck with homes that are worth less than they paid, negating the benefit of the home sale exclusion.
And the lenders who helped any and everyone, regardless of qualifications, get into the housing game have helped bring the whole U.S. economy to the brink.
Some connected the dots: The contribution of the tax law to the housing bubble, says Roberts, has been largely overlooked.
"Do you think that had any effect on the price of housing? You bet it did. Vernon Smith [professor of law and economics at George Mason University and 2002 Nobel Laureate in economics] pointed out the impact in December 2007:
The joint housing and mortgage-market crisis once again reminds us that all financial implosions stem from the same cause: borrowing short and lending long without enough equity to weather periodic storms in the gap between.
But this bubble was different. Besides being fueled by housing purchases and repackaged loans, each with inadequate equity -- doubling down with other people's money -- at the end of the capital-gains rainbow was the right to take up to $500,000 of profit, tax free.
Cafe Hayek also cites BusinessWeek's Christopher Farrell 2005 article in which he said the housing boom at that time was built on disproportionate tax incentives that keep the stock market's rise in overdrive.
"As much as possible, the tax code shouldn't bias investment decisions," Farrell writes. "As it is, the tax code is too heavily weighted in favor of housing. The Urban Institute calculates that the government provides about $147 billion in subsidies to homeowners, including the mortgage-interest deduction and capital gains exemption."
The Tax Foundation's Tax Policy Blog, which gets a big hat tip for pointing us to Café Hayek, also has some thoughts on the economic implications of housing tax policy.
Breaking up tax breaks is hard to do: Of course, any time proposals to change homeowner tax breaks are offered, they are quickly scuttled. The most recent such instance was the President's Advisory Panel on Federal Tax Reform. Its suggestions were quickly shelved.
Have you sold a home and taken tax advantage of the home-sale exclusion? The hubby and I have done so a couple of times.
And I must admit that the tax law worked quite nicely for us when we
unloaded sold our Florida home in early 2005 just before that region's housing market crashed.
Would you support a change in the tax law to even out the taxes on all capital assets? Of do you think that homeowners should get special tax considerations (detailed here), for costs they incur while living in their properties as well as when they sell?