NOVEMBER 19, 2015

TAXES & THE HOMELESS

What determines cost of a home?

One’s initial response may be this: Supply and Demand.

Consider the city of Detroit where thousands have walked away from buildings when they became too expensive to hold for rent or to live in. The supply was there but demand dropped off as manufacturing jobs and all that they supported went away. The city leaders look upon the blocks of houses without residents as blight needing to be bulldozed away. No doubt the realtors of the area are anxiously awaiting the day when the blight is removed and when the recovery from the bankruptcy of the city is long forgotten history. Then new business may once again be attracted to the city and the long period of population exodus may be turned into an influx of new residents needing housing which may then be in short supply.

Anyone who has lived through the last half of the Twentieth Century and the first years of the Twenty-First Century knows that other factors influence the cost of real estate. Among these are the tax deductibility of home mortgage interest and the existing requirements for obtaining real estate loans. The real issues for a new home buyer are monthly cash flow and the belief that real estate price appreciation will continue in the decades ahead.

Those in the United States who bought real estate before or at the beginning of the 1970s (and never moved again) not only ended up living practically rent free (over their entire lifetimes) but also likely wound up becoming millionaires in the most expensive urban areas. A home costing less than $30,000 then might well have had a fair market value between fifteen and twenty times more than that even during the real estate swoon of 2007.

In determining the maximum amount of a real estate loan in the middle of the last century bankers would generally only count one income per household, demand a significant downpayment or a government guaranteed mortgage, and require that the monthly mortgage payment be no more than one quarter of a borrower’s monthly gross income. For the middle class in the 1950s this meant that a home could not sell for much more than $15,000. By the late 1970s all of that had changed. Now a married couple could count both of their annual earned incomes to qualify for a loan. Now they could pay thirty or perhaps even thirty-five percent of their annual income in mortgage payments. And for the first twenty years of a thirty year mortgage most of that mortgage payment was interest and could be deducted from one’s gross income reducing the amount of taxes one must pay.

Real estate prices soared. Rents soared. But lower paid workers saw much less of an increase in the wages they were paid. Where once gas station owners hired people to pump gas for a living and those gas station attendants could afford to buy a home, now those jobs no longer existed and drivers pumped their own gas.

And real estate prices went up everywhere: big cities, small cities, towns, villages, and distant houses on rural lands.

A house sold for whatever the banks were willing to lend. And by 2005 bankers no longer cared about how much they were lending or about how credit worthy their borrowers were. Why? Because they no longer kept the loans that they made. Instead, they sold those debt obligations at a discounted price to investment firms on Wall Street. Then Wall Street packaged those loans into investment products and sold shares of those investments, to pension funds, insurance companies, individuals, and other investors all over the world.

For those who have sold their homes and are living off the proceeds or who are receiving payments from reverse mortgages life appears good.

For those who remain living in their home purchased in 1970, their economic history since then borders on incredible. On their thirty thousand dollar home purchased with a six thousand dollar down payment and a twenty-four thousand dollar mortgage at six percent, their constant monthly house payment between then and 2000 has remained $143.89 while market rental prices rose from $300 to $1,700 per month. For this 1970 home buyer in the year 2000 that was an annual savings of $18,000, after 2000 an annual savings of $20,400 and increasing with each additional passing year after that.

However, of equal if not more importance, is the amount of wage increases that the homeowner received over thirty years as employers had to pay more to attract and to keep workers who were facing ever increasing inflation in the cost of housing and other consumer goods. The new homeowner and employee getting $20,000 in 1970 was likely getting $30,000 in1980, $40,000 in 1995, and perhaps $50,000 in 2005 while only paying $143.89 mortgage payment through 2000, and no mortgage payment after that year.

In 2015 there are now more than 9 million households in America that have a net worth of more than one million dollars ( not counting the value of their primary personal residence ). You can be certain that a large percentage, perhaps the vast majority of those households, owe their good fortune to the deductibility of home mortgage interest and the ever easier credit standards for home mortgage loans during the thirty-five years between 1970 and 2005.

Today in urban areas like New York City and San Francisco one bedroom apartments rent for three thousand dollars a month or more. And these metropolitan areas are faced with an intractable homeless problem.

Among the primary causes that have gotten us here has been the reduction in taxable income from the deduction of interest paid on mortgages, the constant easing of home loan qualifying standards, other policy measures to speed the rapid growth in the price appreciation of real estate and to increase the value of other asset holdings such as stocks and bonds, and Americans’ continued attraction to asset appreciation as a way to get rich for free.

There are only four ways to get out of this economic mess:

  1. A massive increase in the incomes of the less well-to-do individuals without asset appreciation or inflation in consumer prices;

  1. A massive drop in asset prices without increasing incomes;

  1. A write down of the debts associated with assets acquired at prices far above their original economic cost; or,

  1. A combination of all of these possibilities.

One thing is without doubt:

Some individuals, some groups, or maybe all of us will suffer a loss in wealth as a result of any process intended to widely increase the incomes of the less well-to-do and to dramatically reduce the currently inflated asset prices that exist everywhere.

The only question is how that loss should be distributed amongst all of us?

Under the banner of “Job Creation”, some would suggest this plan:

  1. Dramatically cut the taxes of corporations, of other business owners, and of wealthy individuals so that they will be encouraged to start new businesses and thereby hopefully create new jobs;

  1. To make up for the cut in taxes reduce government payments for public pensions, for social security, for medicare, and for all other government programs except for the military services and other national security agencies.

Since the 1980s this type of solution has been tried over and over again with success for some but without great success for all Americans.

If instead we try a program that will be borne by all and that may effectively end speculative asset bubbles, perhaps we will have better results. Since most either own or rent a home and some speculate with borrowed funds, a plan that dramatically reduces real estate and other asset prices may be a step in the right direction.

Here are the likely elements needed for such a plan to work:

  1. No tax or business expense deduction allowed for interest paid on loans for real estate purchases or improvements;

  1. No loans allowed for the purchase of financial assets such as stocks, bonds, or other such investment purchases;

  1. No home mortgage loan allowed if the annual combined cost of the mortgage payment, loan insurance, fire insurance, and property taxes exceeds twenty-five percent of the prospective home buyers’ annual gross income;

  1. Automatic cancellation and write off of any portion of the balance due on a real estate loan that exceeds one hundred percent of the average fair market value over the previous twelve months of the real estate against which the loan is held; and,

  1. Automatic annual business tax deduction allowed equal to five percent of the balance of all real estate loan balances written off by creditors since the enactment of the law requiring write off of any portion of certain outstanding loan balances.

Such a plan would be painful for all. Home real estate prices would fall dramatically as would the prices of rental property. Creditors would lose the value of loans previously extended. The prices of other financial assets would fall to a price more closely equal to their actual economic worth. The cost of monthly rent would fall as the value of the underlying real estate falls. Gradually as the cost of housing is reduced as a percentage of income, the prospects for the economy will improve as consumers have more money to spend. Eventually more of the homeless will find housing that they can afford.

The choice of who bears the cost for such economic changes is up to us.

Will those who have the least suffer the most?

Or will we all share the burden?