March 03, 2008
Dean Baker
The Guardian Unlimited, March 3, 2008
CommonDreams.org, March 4, 2008
See article on original website
While many people in this country are pushing for more money to get health insurance for kids in low-income families, or to pay for their childcare, the politicians have a different idea. The politicians’ plan to help low- and moderate-income families is to have them pay a special 18% income tax to live in a home in which they have no equity.
Here’s how it works. As we know, millions of families are facing foreclosure on their homes because they have mortgages that they can’t afford and live in homes that are worth less than the amount on their mortgages. This is a situation where the banks would ordinarily take a huge hit since they have no hope of recouping anywhere near the amount owed on the mortgages when the homes go through the foreclosure process.
But politicians can’t resist a bank in distress. They want the government to step in and either guarantee or directly issue new mortgages to these homeowners. When these new mortgages are issued to pay off most or all of the prior mortgages, they will be giving the banks far more money than they can reasonably hope to get if the houses had gone through the foreclosure process.
This can be viewed as bad policy because it is giving tens of billions of taxpayer dollars to the truly rich. But it should be viewed as even worse policy because it is effectively taxing millions of low- and moderate-income families to live in homes in which they have no equity. It just takes some simple arithmetic to uncover the low-income homeowner tax in this plan.
Typically, houses sell for about 14 times as much as what it would cost to rent the same unit for a year. The run-up in house prices in the bubble raised the ratio of sale price to annual rent to more than 20 to 1. While prices have begun to fall, in many areas that ratio remains nearly unchanged.
Working from this ratio, it is easy to see that homeowners are almost certainly paying far more to stay in their houses than it would cost them to rent the same home, and that these excess payments are a large share of their income.
Suppose that a moderate homeowner gets a 6% mortgage, and then pays an additional 1% of the sale price each year on both tax and maintenance. This means that their costs of “owning” the house is equal to 8% of the sale price, not counting any payments of principle on the mortgage. Since the rent of the home is just 5% of the sale price the homeowner is paying 60% more in housing costs each year than they would if they were a renter.
Let’s put numbers in this story. Suppose the house would sell for $200,000. The 20-to-1 sale-to-rent ratio implies that it would rent for $10,000 a year or $830 a month. Instead, this homeowner is paying $12,000 a year in interest, $2,000 a year in taxes and $2,000 a year in maintenance for a total of $16,000 a year, or $1,330 per month.
This additional $6,000 a year in housing costs is likely to be large relative to the family’s income. Housing costs average 30% of disposable income, so this sum would be equivalent to an 18% tax on the family’s disposable income. This sum is also roughly what it would cost to insure two kids for a year. It is also almost enough to pay for childcare for a kid for a full year.
Paying extra to own, rather than rent, a home could make sense if the homeowner was accumulating equity in the house. However, this is almost certainly not the case. House prices are falling rapidly and will likely continue to fall until the overhang from the housing bubble is eliminated. The vast majority of moderate-income homeowners facing foreclosure will never see a dime in equity on their home. In other words, the excess housing payments are basically just a tax that gives no return whatsoever to these homeowners.
It is truly bizarre that we are struggling to find ways to pay for healthcare and childcare for kids in low-income families at the same time that the government is encouraging these families to throw large amounts of money away so that they can be called homeowners. Many of these families will still need help for their kids, but they would need much less if we ended the 18% homeowner tax. We need a housing policy that is designed to give people decent housing, not fulfill ideological commitments to an “ownership society”.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues. You can find it at the American Prospect’s web site.
