U.S. homeownership: an international perspective

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This article compares the U.S. government’s homeownership policy with the homeownership policies of other nations to determine the most effective method of promoting a stable housing market. This is the second article in our series evaluating domestic and foreign housing subsidies. The first article can be found here.

The rest of the developed world

As the previous article in this series discussed, the U.S. Tax code is structured to provide incentives for homeownership which, unfortunately, tend to lead only to an increase in debt. The U.S. could improve its own homeownership policies by looking at the tax codes of other nations to find the ideal balance of homeownership-related tax policies.

A recent report from the Organization for Economic Control and Development (OECD) surveyed its 34 member nations in an effort to determine which housing policies have the most beneficial effect on national housing.

The ideal housing market, the OECD determined, is one which:

  • keeps relocation costs low for its labor force; and
  • provides sufficient credit to purchase a home.

An oversupply of mortgage money (credit) leads to negative equity conditions, which make it difficult to relocate and result in serious conflict between these two market elements.

An optimal system, according to the OECD, would tax the rent an owner would pay to rent the same housing (the “implicit rent”), including mortgage interest tax deductions, and under the same conditions as an investment in income property. This can be done through a system of imputed rents, in which a property’s implicit rent is taxed as income to the homeowner for his use of the property in the same manner as any other rental income, less deductions for interest.

Relatively few countries have a policy of taxing imputed rents, although there are some exceptions, including the Netherlands and Switzerland (both of which offer a mortgage interest tax deduction in the form of an offset of taxes on the implicit rental income). Sweden also taxed imputed rents until the mid-1980s, but inconsistently continued to permit the deduction of mortgage interest after discontinuing the imputed rent policy.

Except in special situations, the U.S. does not tax imputed income — indeed, it does the opposite, offering multiple tax-based incentives for ownership without concern for the value of the benefit of occupancy enjoyed by the owner on his invested capital (loan funds and savings).

Although it may be a practical system, taxing imputed rents is not currently a politically realistic alternative to the mortgage interest tax deductions in the U.S. Taxes on imputed rent tend to be extremely unpopular, as they require homeowners to pay for “income” which they do not receive in the form of money. In the present tax-averse Congress, it will be enough of a challenge to repeal and reform current subsidies without imposing novel forms of taxation. Fortunately, other alternatives are available.

The second-best solution advised by the OECD is to remove all subsidies which artificially promote homeownership and mortgage debt over renting a comparable property. The OECD found that approximately half of its member nations permit mortgage interest to be deducted from income taxes. Tax credits for owner-occupancy are somewhat less common. The U.S., however, continues to offer hefty subsidies.

This second choice is more similar to the recommendations given by the Presidential Advisory Panel on Federal Tax Reform (the Advisory Panel) in 2005, which advocated a simplified mortgage deduction limited only to lower-income homebuyers. Given the historical culture of homeownership in the U.S., a more limited, rational and progressive subsidy may be the best we can hope for. In this regard, we would not be so different from much of the developed world. [For more information about the Advisory Panel’s findings, see the Panel’s November 2005 Full Report.]

How U.S. subsidies compare

Although the housing subsidies offered in the U.S. are high, they are not the highest globally. The surveyed nations which provide more tax benefits for mortgage debt than the U.S. include (by level of tax assistance) The Netherlands, the Czech Republic, Denmark, Norway, Greece, Finland and Sweden. Overall, 17 out of the 34 countries surveyed have tax policies which favor homeowners with special tax treatment.

Thus, the U.S. is far from the only nation that offers a mortgage interest tax deduction. In a 1991 survey of housing tax policy of nine G-7 nations, Economist John McDonald, writing for the Office of Real Estate Research, found that mortgage interest tax deductions were permitted in Italy, Sweden, England and the U.S. (England has since discontinued its deduction). Australia, Canada, Germany and Japan did not offer any such deduction, and France offered a tax credit with some comparable effects.

If we are to retain such a deduction, then, the key task will be to insure that it actually performs its intended purpose of promoting ownership among those who would otherwise be unable to purchase a home, rather than merely subsidizing the purchase of vacation homes for the wealthy and encouraging low-tier and first time buyers to accumulate potentially catastrophic debt under economic and financing conditions they have not been trained to understand. [For more information about the uneven distribution of benefits under the existing mortgage interest tax deduction, see the June 2011 first tuesday article, Subsidizing the American Dream.]

The U.S., Germany and our neighbor to the north

With the strong support of trade groups and homeowners alike, it currently seems unlikely that the U.S. will forsake its homeownership subsidies entirely. Regardless of whether ownership is as socially and economically beneficial as its proponents proclaim, it has become ‘common knowledge’ in our nation that private property is a laudable goal; an end in itself.

Interestingly, however, comparisons to other nations indicate that overall homeownership rates have less to do with tax policy than with national disposition toward ownership. While some might consider it blasphemous to ask, there is legitimate reason to question whether even well-designed mortgage-subsidies will actually increase the level of ownership in any meaningful way.

Proponents of tax subsidies like to point to the relatively high rate of homeownership in the U.S. compared to other nations. In California, the homeownership rate was 56% in 2009, and the nationwide rate was 67% (at the time of this writing, both have dropped dramatically from that point, and show signs of continued decline).

Germany, which has few incentives for ownership and is often contrasted withthe U.S., is generally reported to have an ownership rate of 40-45%.

However, a more apt comparison is Canada, which has a homeownership rate comparable to (and sometimes higher than) that of the U.S., in spite of the fact that it provides no interest deduction for homeowners. Australia, likewise, has maintained a homeownership rate of approximately 70% since the 1960s (as reported by the Australian Institute of Family Studies) without the help of taxpayer-funded subsidies. England also maintains a homeownership rate similar to that of the U.S., and has continued to do so since the termination of its mortgage interest tax deduction in the 1990s.

The crucial element in the high level of homeownership in these commonwealth-related nations appears to be a common historical culture of ownership. In Australia, for example, the ideal of owning and living on private property has been referred to as “the Great Australian Dream”; a phrase which echoes our own “home on the range” ideal. Nations such as Australia and Canada offer encouraging examples of the right way to promote ownership, without promoting harmful lending behavior and inflated property prices.

Furthermore, while each of these countries suffered in the global recession that began in 2007, none saw their housing markets collapse as the U.S. did. The crucial difference was the huge amount of mortgage debt held by American homeowners. In Canada, even at the height of the boom, the average homeowner held approximately 70% equity in his property. The comparable amount in the U.S. was approximately 30%.

The threat of debt in the U.S. and abroad

Countries that do use housing subsidies include Ireland, Spain, India, the Netherlands, Sweden, and Switzerland. Spain, for example, permits homeowners to deduct up to 15% of mortgage interest in a program similar to the U.S.’s. Partially as a result of this subsidy, Spain saw its housing market inflate in the early 2000s beyond even what the U.S. experienced. Spanish home sales more than doubled between 2003 and 2006. Between 1997 and 2007, Spanish home prices rose over 200%.

The results are now infamous. In the market crash of 2007, Spain’s housing market experienced one of the worst mortgage crises worldwide, and home sales now remain at levels comparable to 2003. Construction, which enjoyed a corresponding boom, dropped by almost 11% throughout Spain by the end of 2008. The vacancy rate sat at over 20%. Spain’s real estate collapse was, and remains, among the worst experienced in any developed nation.

Spain’s burgeoning personal debt was accompanied, much like the U.S., by tremendous national debt. Burdened by its lack of liquidity, the Spanish government was unable to take measures necessary to assist its people. The young members of the middle class were especially hard hit, and suffered from an unemployment rate of approximately 40% in May 2011. On May 15, 2011, widespread protests broke out across Spain. The local and regional elections which followed one week later saw the overthrow of Spain’s formerly dominant socialist party.

Not coincidentally, Spain accompanies three other Euro-nations — Portugal, Ireland and Greece — which have proven most incapable of paying for their massive government debt. These nations borrowed heavily, using the strength of the Euro to hide the comparative instability of their own national economies, and have since been forced to deal with the consequences. Their government solvency disasters — termed the “PIGS” crisis by economists — is a warning about the results of untrammeled government debt.

In the U.S., fears of the growing national debt have become commonplace, yet the market in government treasuries shows no causes for concern as of yet, unlike those countries in the PIGS crisis. While the U.S. needs to be careful to avoid harming the nascent recovery by imposing fiscal austerity before 2013, Wall Street is correct in its demand that the federal government begin to implement laws for debt reduction to take effect by 2013. At risk in the bond market are both the U.S.’ continued ability to fund necessary programs and its credit rating, which determines the rates at which other nations are willing to lend us the dollars they hold. Homeownership debt plays a long hand in this card game.

What homeownership should be and may become

While the home interest subsidy is not wholly to blame for housing market woes in Spain or the U.S. (far from it), the real culprit is the mortgage debt which that subsidy encourages. After the Great Recession, policies that encourage debt, like subsidies for mortgage loans, have been revealed as an untenable homeownership risk, especially the loopholes that encourage the use of equity financing for the ownership of second homes as implemented in 1986 tax legislation leading directly to the home equity line of credit (HELOC) fiasco and short sale interference.

Subsidies for homeownership have become newly controversial in many countries that still offer them (the U.S. included). In some nations, like the Netherlands, their repeal has already come up for vote. As time passes, the tax loophole which costs the federal government billions and provides no increase in homeownership and little or no help to more needy low-income homebuyers, is becoming increasingly egregious deficit exposure for our government.

Brokers, mortgage lenders and builders need to realize that the recent financial crisis and recession point toward a redefinition of the nature of homeownership.

If it learns from the past, the U.S. will implement policies which see the home as a “family nest” meant to be free of risk, not an ATM to pull out cash from equity as in the treatment of an investment. Rather than a return to the hazardous volatility of the boom years, the nation needs a return to the stable property values and sustainable homeownership rates of the 1960s, 1970s and 1980s.

Such an economy will also, of necessity, have room for renters. Rentals are the natural and preferable method of housing for those who, for economic or social reasons, prefer not to own the residence they call home. By removing the stigma from rentals, greater stability and quality of multiple housing can be achieved for all. [For more on the advantages of rentals, see the first tuesday Market Chart, Rentals, the future of real estate in California?]

Germany’s housing policy provides a good example of a healthy long-term rental economy.. Instead of a mortgage loan interest deduction, which encourages debt, Germany provides a depreciation allowance for the first eight years following the construction of a new property which encourages housing complexes in urban cultural areas. Sweden uses a similar program, offering reduced property tax rates for the first ten years after a property is constructed.  Builders and property managers also benefit.

The goal is not to work against ownership, but to discourage extravagant debt among those who are unable to manage it. Our government, both state and federal, should phase out policies that inflict financial harm on homeowners to the benefit of lenders, and replace those policies with new, cost-effective taxes and incentives which meet with the needs of both homeowners and renters.

This process will involve the elimination  of all tax reduction loopholes which encourage debt (including deductions for interest, origination fees and private mortgage insurance/mortgage insurance premium (PMI/MIP), as well as those policies which encourage homeowners to sell their present home rather than retain ownership of it and, as is the case in states like California, allow the deduction of extremely low property taxes when the supplemental and equivalent retail sales tax is not deductable.

Although the reform of subsidies has historically proven politically unpopular with those who appear to benefit – most recently in 2005, the Advisory Panel’s recommended repeal of the mortgage interest tax deduction was met with widespread derision – the post-recession population is newly aware of the dangers of debt and of ill-conceived fiscal policy. With luck, the time may soon be ripe for tax reforms which will return the U.S. housing market to a level which equals and even surpasses the strength and stability of the world’s best-designed economies.

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