Home Builders Study Shows Tax Subsidies Highly Concentrated Geographically

July 21, 2006

In an attempt to call out specific members of Congress in order to get their backing of the special provisions in the tax code related to housing and more specifically to get their opposition to the recommendations made by the Tax Reform Panel last October, one of the biggest beneficiaries of these tax distortions, the National Association of Home Builders, has recently released a report detailing where the housing tax subsidies are most prevalent.

Among the findings:

The top six congressional districts in terms of cumulative mortgage interest total more than $15.5 billion and are located in the Golden State. By contrast, the five congressional districts with the least mortgage interest deducted are located in the New York City metropolitan area, where renters exceed the number of home owners. (Courtesy NAHB Report Summary)

Homeowners in California’s 14th Congressional District claimed $3.2 billion in mortgage interest deductions during the year covered by the study, compared with $2.9 billion by all the residents of Vermont, Wyoming, West Virginia, Alabama, North Dakota and South Dakota. The average deduction in the 14th District was $35,000, compared with an average of $9,500 for homeowners nationwide. (Courtesy Baltimore Sun)

Residents of a single congressional district on Long Island wrote off more in real estate property tax deductions than all the homeowners from seven states combined. (Courtesy Baltimore Sun report)

The Baltimore Sun article closes with this summary of the stance taken by defenders of these tax subsidies, of which they benefit enormously.

Defenders of the current system – the National Association of Home Builders is one of the most outspoken – argue that the disproportionate write-offs are attributable to the starkly different realities confronting homeowners from state to state.

For example, New Jersey and New York residents get to deduct more for local property taxes because they pay much higher taxes than people who live elsewhere: Their state governments rely more heavily on real estate tax revenues to run schools and other government services. California homeowners write off far more for mortgage interest because they pay a lot more for their houses and they have the biggest mortgages, on average, in the country.

There are numerous fallacies with this logic that the federal government should somehow compensate through the tax code those in areas with high housing costs and/or high local taxes. The fallacies exist both on the grounds of inequity and economic inefficiency.

First off, the price of a home at any given point in time captures the present value of the expected benefit stream to the homeowner throughout the life of the home as well as the expected capital gain in the home’s price. (See Jorgensen) This is true of a home on Long Island or a home in Nebraska, and the free market will determine the value of the housing services to individuals living in the two respective places, as well as the expected future value, and thereby determine the relative price between a home in Long Island and a home in Nebraska. So why should those homeowners in Nebraska have to subsidize those homeowners in Long Island just because the value of housing services in Long Island is greater than that in Nebraska?

Oddly enough, this subsidy creates an even bigger gap between the price in Long Island and Nebraska because much of the tax subsidy is included in the value of the housing services, and thereby already priced into the value of the home at the time of sale. (This, however, is why the issue of getting rid of these tax subsidies may often lead to the complaint that the price they already paid for the home assumed that the tax subsidies would be there. Transition costs are therefore always an issue in tax reform.)

Second, the fact that housing is so heavily subsidized by the tax code creates distortions throughout the rest of the capital markets. These special tax provisions distort the comparable rates of return between housing investments and non-housing investments, and thereby artificially pumps more money into housing. Therefore, the overall economic efficiency gains from the special tax treatment of housing are small, if not negative. That is, because the welfare gains from this targeted “tax cut” are small as a result of the capital market distortion, the economic losses associated with the foregone government services and/or increased debt (i.e. increased future taxes) most likely outweigh these “tax cut” gains. Our conclusion: policymakers should not be bogged down with these issues of the special tax provisions for certain industries that may lower overall tax liabilities. Rather, the question they should be asking is whether or not the welfare gains from an across-the-board tax cut that treats all investments equally would exceed the welfare losses from the foregone government services and/or increased debt.

Finally, as for the argument that taxes are higher on Long Island than in Nebraska, the obvious question is why should that be a role for the federal government to remedy? In our federal system, each individual locality is free to determine the level of government services and thereby the level of taxation. And similar to housing, this deduction for local taxes paid even exacerbates the gap between Long Island and Nebraska because lower local taxes artificially lowers the price of additional government services for those in Long Island, which encourages even more government spending and higher local taxes.


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