Wednesday, August 28, 2019

The Housing Market Continues to Prove That Economics Is a Guessing Game -- Even For Dissenting Economists Like Me

by Neil H. Buchanan

When I write about economics, I typically explore the many ways in which orthodox theory is wrong.  Very, very wrong.  In particular, I have spent a great deal of time (see recent links here) explaining how the notion of economic efficiency (or Pareto efficiency, for the jargon nerds) is a facade that allows conservative economists to pass off rank opinionating -- Minimum wages are bad!  Corporate taxation distorts the economy! -- as objective science.

My counterclaim is not that those of us who dissent from the orthodoxy possess what mainstream economists only claim to possess: an objective theory that transcends morality, politics, and human judgment.  Instead, I say simply that there is no way to wring philosophy and ethical choices out of policy decisions, so we should respect facts and logic but be aware of where those things end and human judgment begins.

This does not always prevent areas of agreement between the majority and the dissenters.  For example, most economists who pray at the altar of efficiency nevertheless believe in responsive monetary policy to stabilize the economy, and most also agree that countercyclical fiscal policy is a good idea at least in relatively extreme cases like the Great Recession of 2008-09.  We all agree that spending public money to subsidize individual businesses or industries is either a waste or at least must be justified by some policy goal (such as developing alternative energy technologies).

Perhaps the safest area of agreement and overlap, however, is in our attitudes toward home ownership subsidies, most particularly our universal disparagement of the mortgage interest deduction (MID) in the tax code.  Recent evidence suggests, however, that at least one of the underlying points of agreement is one on which we might all be wrong.  What if the MID simply does not matter much at all?

Earlier this summer, I returned for the first time since 2012 to writing about the rent-or-buy question in personal residences.  I had always found it puzzling that both policy and social mores have pushed people toward home ownership, almost as a rite of passage into true adulthood and full citizenship.  Buy a house, deduct the mortgage interest and property taxes, and be a grownup.  It is the American Dream!

I still find the whole thing perverse, because it encourages people to put all of their wealth into a single asset that is illiquid and that can lose value suddenly and unexpectedly.  As nest eggs go, a house can be a very iffy thing indeed.

But my focus today is on the overlap of opinions between economists of almost all stripes in how we think about home ownership subsidies in this country -- not just the MID and property tax deductions, but the whole range of loan subsidies and loss protections that we have created at all levels of government.  Suburban developments did not simply spring up out of an interaction of supply and demand; they had to be built with public money, the exercise of eminent domain powers, a welter of property law changes (especially zoning), and so on.

It is true that an economist who relies on orthodox efficiency analysis can oppose all of that, decrying the government's "intervention" in the housing market and saying that the MID and other policies create inefficiency.  But one can also argue that, even if there is no natural baseline against which to measure how many people should or would own their houses rather than renting them in a no-government-intervention world, the results of pro-ownership policies are perverse and indefensible.

Typically, mainstream economists will use the word "distortion" as a synonym for "inefficient," essentially saying that policy X (for example, the MID) causes more purchases of homes than the undistorted supply-demand interaction would have generated.  That, as my writing has attempted to demonstrate again and again, continues to be incoherent.  Even so, I can readily agree that a policy decision that changes what people would do -- that distorts their decisions not from an incoherent baseline but that simply causes them to do more or less of something than they would have done without that policy -- might be a bad policy based on some defensible criteria.

What are those criteria?  In the case of housing, it is not only the bad financial planning that I described above that argues against ownership subsidies.  Ownership makes people less mobile, decreasing their ability to move to better jobs when the local economy (or just their own job) dries up or becomes less appealing.  It makes people more likely to engage in what we might call second-order racism, which is the belief that other people's racism will cause home values to decline when a neighborhood integrates, causing even a non-racist person to have a financial interest in exclusion.

And the list goes on.  Most importantly, the arguments in favor of subsidizing ownership over renting do not hold up to scrutiny.  For example, after controlling for residents' age, income, and so on, it turns out that -- contrary to widespread belief -- neighborhoods are not safer or more stable when the houses and/or apartments are owned rather than rented.

That means that a dissenting economist like me can look at the housing market and ask why the tax code is being used to induce more people to own rather than rent, especially given that enacting such a subsidy through the tax code all but guarantees that the benefits will flow to wealthier people.  We might also think that it there is no good argument for the government to cause houses to become bigger over time.

Back in 2011 and 2012, when I was writing about this much more actively, I ended up tempering my initial enthusiasm for ending housing subsidies when I noted a thorny problem.  If people buy and sell houses after taking the subsidies into account, then owners are going to be blindsided by changes to the value of their homes when those subsidies are eliminated.  Essentially, I concluded that the people who currently own homes bought them at prices that were inflated by the subsidies, and they should not be penalized by having the subsidies taken away before they sell.

This argument has the disadvantage of being open-ended, that is, justifying the continuation of what was ex ante a poor policy choice because there is no good point at which to undo that bad decision.  Even so, that is where we were, and it seemed important to face up to reality rather than pretending that the self-reinforcing error was not in fact self-reinforcing.

But what if the underlying assumption -- on which both mainstream and dissenting economists agree -- is untrue?  A recent article in The New York Times reports on an underappreciated aspect of the otherwise-terrible 2017 tax bill that Donald Trump and the Republicans rammed through without hearings, analysis, or even intellectual coherence.  (Republican senators who had staked their careers on being deficit hawks, including retiring senators who had no reason to worry about political blowback, voted for it.  The late John McCain, now revered as a man of principle, complained about the lack of "regular order" in the Senate but then voted for a tax cut bill that had been created without the slightest bit of order.)

In any case, as a practical matter the 2017 tax bill all but eliminated the mortgage interest deduction.  As the Times reporters (Jim Tankersley and Ben Casselman) point out, that bill  made it much less likely that people would itemize their deductions, thus indirectly making people less likely to use the MID.  The bill also limited the MID for those who do use it to $750,000 of mortgage principle rather than the previous limit of $1,000,000.  Accordingly, the share of taxpayers taking the MID in 2018 dropped to 8 percent from 21 percent the year before the law was changed.

It is sort of amazing that the number was so low even before 2018, given how mythically potent the MID has been politically, but the number of people in the $200,000-and-higher income range who used it was 72 percent before the law changed.  Their views tend to be overrepresented in policy discussions.  Even they, however, are now using the MID much less -- down to 43 percent of that group took the deduction in 2018.  If they had been inclined to make noise politically about that, the sheer mess of the overall tax bill made it nearly impossible to organize against it.

What "should" have happened to the housing market, now that the MID has been by stealth all but eliminated?  Prices should have fallen, as buyers adjust their willingness to pay computations and sellers are forced to take a hit on the accumulated equity in their homes.  That is the inevitable result of the loss of subsidies, according to both the mainstream economists and the dissenters.

But it seems that the inevitable simply did not happen.  It is in some ways too early to say with certainty, but Tankersley and Casselman summarize the evidence and interview enough experts to make the case that even housing markets that would have seemed most vulnerable to the change -- mid-range homes where middle-class people stopped itemizing entirely -- have been unaffected by the loss of the MID.  Some areas have seen mild softening of price increases, but there are plenty of non-MID explanations for that.  The bottom line is that the reporters could find only one economist who argued that the loss of the MID was having the predicted effect on prices, and that was a guy who works for the National Association of Realtors.  (Not, in other words, an unbiased source.)

Now, it is true that we are living in the period of low interest rates, which the article somehow fails to mention.  Still, this is kind of amazing.  What can we make of it all?

I am reminded of the fierce arguments by conservative economists that states like California and New York are harming themselves by imposing high taxes, making themselves uncompetitive.  They then point to the golfer Tiger Woods and say that he moved from California to Florida because of the tax difference.

And as a matter of economic prediction -- again, prediction not based on fealty to the efficiency god, but merely as matter of trying to think through how people will react to incentives -- there is something quite alluring about the claim that people will move (at least within a country) to lower-tax areas.  But it turns out to be spectacularly false as a matter of reality.  Study after study has shown that people and businesses do not move because of relative state taxes.  California and New York are doing quite well, thank you very much, and the anti-tax ranters are proved wrong again and again.

Maybe the worry about ending housing subsidies is in the same category.  Even in my column this past June, I wrote confidently:
"I am no longer convinced that we could or should cut the supposedly 'artificial' supports out from under the market for individual home ownership.  Too many people have too much to lose when prices fall, and it is not at all clear that repealing the MID or federal loan guarantees will leave us in a better position."
If it is true that the prices do not fall when the supports are cut out, then maybe there is no good reason to maintain those supports.  To be clear, there could still be good reasons to cut the supports in any event, and because I concluded that those other reasons were not good enough to overcome my concern about falling prices, at least my previous conclusion is undermined by this new evidence.

People can be surprising.  Economists of all stripes tend to start with the assumption that people will respond predictably to incentives.  When that does not happen, we need to think again.

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