Posted by Frugal on 28th February 2008
I think few people realize that America/the world is facing the biggest financial storm ever, and how dangerous it is for investing in stocks before a full implosion. The housing-induced credit crisis has gone far beyond anyone can potentially control, probably not even the Fed.
Reading over so many current/future proposals from politicians and bloggers, I have my own thoughts in this. For sure, there simply isn’t a solution without pain. But there can certainly be solutions that are more fair and less pain.
One of the most fair and easiest way to help propping up the housing market is to subsidize all the buying or holding cost for primary residences. Instead of helping on the sell-side directly, the government can help the buy-side. Of course, the subsidy will indirectly go into sellers. But the solution is market-based.
Why is this a fair solution? For sellers, there is simply no direct bailout. For anyone who chooses to buy, the buying decision is done on the open market where everyone else is competing on the same ground with subsidy, and existing real estate investors will also be helped with a more stable housing price. For any renters who choose not to buy and take up the subsidy, their decision is solely of their own based upon their evaluation of the current housing market and personal circumstances.
What kind of subsidy will make sense? The easiest way is certainly done through mortgage interest reduction or tax deduction. The tax deduction cannot be limited by the amount of adjusted gross income, and has to be actually beneficial on top of the existing standard deductions. By reducing the overall housing cost, government will encourage more of it, and prop up the housing market.
Since 65% to 70% of the Americans are home owners, most of this housing aid will effectively become a tax cut for middle class. I suggest that 50% of the total amount of both property tax and mortgage interest from primary residence can be used as a tax credit (rather than tax deduction in the itemized section). Here are some examples of the housing aid scenarios, with loan interest at 6%:
1. $700K home in California with 20% down for someone with tax bracket at 28%:
Because loan amount is $560K, the interest is $42K a year, and the additional tax subsidy amount will be roughly (50% – 28%) * $42K / 12 months = $616 a month. This monthly subsidy will effectively lower the interest rate from 6% ($3357) to 4.25% ($2755). That will be a tremendous stimulus.
2. $500K home with 20% down for someone with tax bracket at 15%:
The additional tax subsidy amount will be roughly (50% – 15%) * $500K * (1-20%) * 6.00% / 12 months = $700 a month. This monthly subsidy will effectively lower the interest rate from 6% ($1852 payment) to 3% ($1686 payment). This is an even better deal for lower income people.
Effectively speaking, this tax cut will target middle-class home owners specifically. Using the assumption of a median home value of $240K, and an average tax bracket of 15%, this tax aid comes to be about $4032 dollar per family household, 110 million US households, with 70% home owners, it will be about $300 billion annually. I’m not going to re-do my numbers here, but probably instead of 50%, one could go for 40% of the interests as tax credit. This will adjust this bill from $300 billion to about $214 billion. I hesitate to go to much lower, simply because in California, where most of the housing problems are, you have to be at 25% to 28% tax bracket to afford the homes. Since one is already getting existing tax benefits at 25% to 28% through itemized deduction, the 40% as tax credit will only give 15% to 12% additional benefit.
Bottomline, this printing of tax money will be truly the best way of distributing the helicopter money, since it goes to the homeowners directly without discrimination, AND it is also tax-progressive. The rich who has a bigger loan do get a lot more, but only because they are paying a lot more for their home. But the middle class will not be left out at all, and will enjoy the biggest piece of the tax reduction. This will effectively encourage home purchase/consumption, and props up housing market. The solution is also market-based without ANY bailouts to those people who abuse the mortgage markets.
In respect to Republican tax position, this is a market-based solution. In respect to Democrat tax position, this is a tax aid for most of their incumbents. In respect to stock markets and US economy from Keynesian economics, this is a huge positive. Tax cuts stimulate economy. On the other hand, money from direct taxpayer bailouts go into the pockets of these fraudulent bankers and homeowners, and continue to encourage moral hazards and speculation.
Frugal at 1stMillionAt33.com