Edward Glaeser Commentary: Rolling the Dice on Wasteful Home Subsidies

Boston Globe

FEDERAL POLICIES bear some of the blame for the housing bust because they encourage leveraged bets on housing. Yet instead of reconsidering the public incentives that encourage real estate gambling, the federal government seems ready to double down, with another $35 billion in Treasury support for state agencies that subsidize borrowing, and the reauthorization of an $8,000 home buyer’s tax credit. The ship of state would do better to turn around and reduce borrowing subsidies, by lowering the million-dollar cap on the home mortgage interest deduction.

Presidents from FDR to George W. Bush subsidized real estate borrowing through government-sponsored agencies that insured mortgages, like Fannie Mae and Freddie Mac, and through the home mortgage interest deduction. These policies encouraged homeownership, but they also encouraged people to buy bigger homes and to finance those homes with high loan-to-value mortgages.

All that leverage left Americans extremely vulnerable to swings in the housing market. In the fat years between May 2002 and May 2006, according to the Case-Shiller index, housing prices soared by 64 percent and places like Boston became increasingly unaffordable. Since then, housing prices sank by 32 percent. Many economists think that easy credit caused the housing bubble. That is debatable, but no one can doubt that highly leveraged home buyers lost their shirts when the bubble popped.

The home mortgage interest deduction is particularly problematic. The average benefit from that deduction is 10 times higher for households earning more than $250,000 than for households earning less than $75,000. The wildly regressive nature of the deduction explains why it is relatively ineffective at boosting homeownership. The deduction’s benefits accrue mainly to the wealthy, who would have owned homes anyway.

Encouraging spending on housing induces people to buy larger and larger homes, which use more energy and create more carbon emissions. The threat of global warming warrants policies that encourage smaller homes.

Policies that favor homeownership are also anti-urban. More than 85 percent of multiunit dwellings are rental and those bigger buildings are disproportionately in urban cores. Newer, larger homes tend to be suburban. The federal policies that encourage more spending on homes also encourage an exodus from the nation’s cities.

The fans of new home-buying subsidies argue that they will boost housing prices, but that is more cost than benefit. Housing prices appear to have stabilized, at least for now, and there is no reason to try to create a new bubble. In areas like Greater Boston, where the housing supply is relatively fixed, subsidizing home buying does increase prices, but that just transfers money from poorer home buyers to richer homeowners. Public policy shouldn’t try to make cars or clothes more expensive, and it shouldn’t try to reduce housing affordability either.

Supporting homeownership is sometimes advocated as a means of encouraging asset accumulation, but it makes little sense to encourage investing in one particular asset class. A diversified portfolio is always safer than a leveraged bet on one particular home. The wreckage of the housing market would have been less painful if America had embraced a more balanced tax policy that encouraged all forms of savings.

A tax credit for first-time home buyers would be reasonable if the credit was a substitute for policies that subsidized borrowing. If America wants to subsidize homeownership, then a flat tax credit makes more sense than a credit that scales up with the size of one’s mortgage. Homeownership is associated with more civic engagement, but there is no evidence to suggest that owing more money does anything good for a community.

In 2005, President Bush’s tax reform panel recommended reducing the upper limit on home mortgage interest deduction from $1 million to less than $500,000. Reducing the upper limit would reduce the incentive to overborrow and overbuild, and it would do little harm to middle-income Americans. President Obama’s inaugural speech promised a “new era of responsibility,’’ and so it should be in housing. Our policies should encourage people to live in housing they can afford, not to borrow as much as possible.

Edward Glaeser is director of the Rappaport Institute for Greater Boston and the Taubman Center for State and Local Government at Harvard Kennedy School. The views expressed in this article are his own.