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Wednesday, January 29, 2014

Kahng: Path Dependence in Tax Subsidies for Home Sales

Lily Kahng (Seattle), Path Dependence in Tax Subsidies for Home Sales, 65 Ala. L. Rev. 187 (2013)

At a time of looming fiscal crisis and virtual unanimity that tax expenditures must be curtailed, tax subsidies for homeownership stand out as among the most costly and unfair of these expenditures. As a result of tax subsidies for homeownership, the government foregoes billions of dollars in revenue each year, most of which benefits wealthy taxpayers. Moreover, subsidies for homeownership encourage overinvestment in housing and underinvestment in other business sectors, which impedes economic productivity, jobs creation and the ability of U.S. businesses to compete in the global marketplace.

Scholars and commentators have analyzed extensively the tax subsidy for home mortgage indebtedness but have paid little attention to tax subsidies for home sales. This Article is the first to undertake a comprehensive examination of tax subsidies relating to home sales. The central thesis of this Article is that these subsidies rest upon questionable policy justifications, flawed logical reasoning, and poor design choices. To support this thesis, the Article traces the evolution of tax subsidies for home sales from their surprising origins in a World War I-era tax preference for requisitioned ships to their present incarnation as a practically unlimited tax exemption. This narrative account leads to several important findings. First, it shows how path dependence and bounded rationality have led lawmakers and policymakers to make questionable decisions and support problematic laws. Second, it demonstrates the power of the real estate lobby to shape the story — and the resultant legal rules ― from both tax and social policy perspectives. Finally, it illuminates the political and rhetorical forces that have shaped tax subsidies for home sales. The Article argues that only by understanding where we were before and how we got to where we are now, can we properly assess where we should go from here.

In assessing tax subsidies for home sales, the Article evaluates the subsidies by reference to the established tax policy criteria of efficiency and fairness while remaining cognizant of the broader context of the social and economic policies regarding homeownership. Although a comprehensive assessment of federal housing policies and the role of tax subsidies in structuring the domestic housing market lie beyond its scope, the Article offers important new insights that will contribute significantly to the ongoing policy dialog about homeownership in our society. In particular, it analyzes the economic impacts of tax subsidies for home sales, including whether and to what extent the subsidies contributed to the real estate bubble. Moreover, the Article highlights the important, but underappreciated, disparate race and gender impacts of homeownership as a wealth-building vehicle. Finally, the Article calls for the repeal of tax subsidies for home sales and argues that the “exogenous shock” of the global financial crisis presents a rare and fleeting opportunity to effect this reform.

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From the article: "The liquidity and the unfair shock problems are relatively minor, at least for the time being, for two principal reasons. First, capital gains rates are at historic lows (zero or five percent), for all but the top one percent of taxpayers, whose capital gains rate is also quite low (twenty percent)."

The author is seriously out of touch with today's effective marginal tax rates. In California a person with a $200,000 one-time taxable capital gain from a home sale and moderate wage income would face a state tax rate of 9.3% plus a federal tax rate of 22% due to phaseout of the AMT exemption, plus the 3.8% Obamacare tax. That adds up to about 35% without considering any other phase-outs of tax benefits such as IRA eligibility or education credits. 35% is a large bite when you only wanted to move to a house of the same value in another town.

It's strange but revealing that the article makes virtually no mention of inflation. Inflationary gains, in step with the housing market as a whole rather than property-specific gains, are the bulk of capital gains on home sales. Is it fair for the government to tax people on "gains" which merely reflect depreciation of the currency? I don't think so, but the author clearly does.

Posted by: AMTbuff | Feb 2, 2014 2:07:19 PM