Rethinking tax breaks for homeowners

Reuters

A woman jogs by new housing construction in Darnestown, Maryland, October 23, 2012. New US single-family home sales surged in September to their highest level in nearly 2-1/2 years, further evidence the housing market recovery is gaining steam.

Article Highlights

  • As policy makers reevaluate popular tax breaks in the face of growing revenue needs, they should carefully rethink the rationale for favoring homeownership over renting.

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  • According to the Congressional Budget Office, the effective tax rate on owner-occupied housing is negative, while the effective tax rate on rental housing is around 18 percent.

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  • Unfortunately, the evidence for the spillover benefits of homeownership is weak at best.

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  • Reducing or eliminating subsidies for homeownership may therefore both raise revenue and improve economic performance.

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In a radio address on May 11, President Obama argued that "few things define what it is to be middle class in America more than owning your own cornerstone of the American Dream: a home." This popular narrative is found on both sides of the political spectrum, along with strong political support for tax policies that heavily favor owner-occupied housing over rental housing. According to the Congressional Budget Office, the effective tax rate on owner-occupied housing is negative, while the effective tax rate on rental housing is around 18 percent.

This emphasis on homeownership is often justified by the claim that homeowners are more likely than renters to be good citizens who contribute to their communities. Another claim holds that the children of homeowners are better off than the children of renters. For example, a National Association of Realtors television ad asserts that "homeownership builds communities" and "contributes to higher self-esteem and better test scores" for kids.

If homeownership has spillover benefits to people other than the homeowner – for example, if it strengthens communities or improves children's outcomes – then it might merit favorable tax treatment. If not, then it's better to let the market decide whether people own or rent. Unfortunately, the evidence for the spillover benefits of homeownership is weak at best. As policy makers consider fundamental tax reform, they should revisit the arguments offered for homeownership tax breaks.

Proponents of homeownership subsidies frequently point to studies documenting that, even after controlling for other individual characteristics, there is a correlation between homeownership and various measures of community participation and children's outcomes. For example, in a 1999 study, Denise DiPasquale and Edward Glaeser found that homeowners are more likely than renters to belong to nonprofessional organizations, to know the names of their elected officials, to vote in local elections, to garden and to attend religious services regularly – all things that arguably contribute to the broader community. A 1997 study by Richard Green and Michelle White showed that the children of homeowners are less likely to drop out of school or become teenage parents than the children of renters.

But merely finding a correlation between homeownership and good citizenship or successful children doesn't mean that homeownership actually causes either of these outcomes. It's possible that homeowners are different from renters in subtle ways that are difficult to measure and control for. It could be these traits – rather than homeownership itself – that cause homeowners to be good citizens and to raise more successful children. If that's true, then policies that encourage renters to become homeowners are unlikely to strengthen communities or improve the well-being of children.

Some recent studies have provided support for this view. For example, in a 2009 article, David Barker and Eric Miller showed that controlling for additional differences between homeowners and renters casts doubt on the relationship between homeownership and children's outcomes.

The lack of a clear causal link between homeownership and good citizenship was also confirmed in a 2010 article by Gary Engelhardt, Michael Eriksen, William Gale and Gregory Mills. This study was based on a randomized experiment, the best kind of setup for examining questions like this. In the experiment, participants in Tulsa, Oklahoma were randomly assigned to either a treatment group – which received generous matching funds for saving towards buying a new home – or a control group, which received no matching funds.

Thanks to the random assignment, one would expect individuals in the treatment group to be similar to those in the control group. The authors found no evidence that promoting homeownership among individuals in the treatment group increased their political participation or other forms of community involvement.

As policy makers reevaluate popular tax breaks in the face of growing revenue needs, they should carefully rethink the rationale for favoring homeownership over renting. On balance, there is no clear evidence to suggest that homeownership causes stronger communities or better outcomes for children. Reducing or eliminating subsidies for homeownership may therefore both raise revenue and improve economic performance.

Sita Nataraj Slavov is a resident scholar at the American Enterprise Institute.

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About the Author

 

Sita Nataraj
Slavov
  • Economist Sita Nataraj Slavov specializes in public finance issues dealing with retirement and the economics of aging. Her recent work has focused on whether retiree health insurance encourages early retirement, the impact of widowhood on out-of-pocket medical expenses among the elderly and the optimal time to claim Social Security. Before joining AEI, Slavov taught a variety of economic courses at Occidental College: game theory, public finance, behavioral economics and econometrics. She has also served as a senior economist specializing in public finance issues at the White House's Council of Economic Advisers. Her work at AEI will focus on Social Security and retirement issues.


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