One problem among us voters is that we have difficult time grasping the concept that we can’t vote for what we’d like to have happen, but instead vote merely for people and measures that may or may not achieve what we’d like to have happen. We don’t get to vote for peace, for example – we just get to vote for people who’s idea of peace might be the Arab Spring and helping Iran get nuclear weapons, alienating allies and emboldening enemies. We don’t get to vote for jobs – we just get to vote for people whose fundamental economic theories are mid-19th century adolescent revenge fantasies dressed up like philosophy for Halloween – trick and treat, where the treat is everything you’ve got and the trick is burning down your village.
This muddle is exacerbated by the often not-so-subtle Marxism that has replaced thought in all of academia and much of real life. Under this theory, progress is inevitable, the result of the dialectic’s inexorable glorious synthesis of the ragged, unjust thesis and its groaning, tattered antithesis. The only question is: are you on the Right Side of History? Which, translated to English from Newspeak, means: do you chose the correct ends? This sort of non-thought has two consequences: first, the means are judged only by if they effect the ends; second, the only way the proper ends can fail to arrive (in a cloud of dialectic magic unicorn faerie-dust) is if Bad People – oppressors – are actively doing something to stop it. Not that they can stop it, really, because the brave new world is inevitable, but those bad-thinking Oppressor McOppressys out there sure make people on the Right Side of History mad!
It makes me a meanie that I care not so much about the nice sounding stated goals which are often completely noble and desirable, but care a lot about how those goals are to be achieved and – here’s where you’ll really make enemies – if the proposed methods are at all likely to get you there. The burning example these days seems to be minimum wage laws. Would I like everybody to live well? Sure! Would I like poor working people to make more money? Seems OK! So the only reason I can possibly have for suggesting an increase in minimum wages is not a good idea is that I’m a Hater! I love looking down on poor people, who are lazy bums!
Right? It can’t be that I take a larger, better informed picture of economics, wherein the apparent short-term gains of some people from an increase in their personal income is offset by a whole cascade of other, less beneficial events, which will result, eventually, in Bad Things for more people than are helped out. Or if I were to suggest that some jobs really might not be worth $15/hour – that’s not because I understand the economics from the point of view of the guy paying the $15/hour, but because I hate the guy who will, in theory, receive the $15/hour.
So, since I’m a hater anyway, might as well point out a couple other areas where good intentions coupled with economic ignorance produced unexpected (by the economically illiterate) results.
Let’s skip over the part toxic mortgages had in the late economic unpleasantness, and look at the root of the issue.
Let’s say you notice that people who own their own homes are, on average, better off, more stable, and better all-around citizens than people who rent. And, having received an excellent American education anytime over the last century or so, you are unable to distinguish cause from effect, and therefore believe that the government should promote home ownership (under the Commerce clause, I suppose) in order to make people better off, more stable and the kind of citizens who will reliably vote for geniuses like you.
So you do hard thinking (1): On reason people don’t own homes is because they don’t have money. Now, while in the big scheme of things, you’re perfectly OK with just giving people who don’t own homes money, short term, those meanies on the Wrong Side of History won’t let you. No, it looks like, for now, we can only help people who only have a regular income, but not enough saved up to buy a house.
So, how about this? How about we make it easier for people to borrow the money they’d need to buy a house? We do this by allowing them to deduct the interest on home loans from their taxable income.
Let’s say I make enough money to afford a $650 per month rent payment. Turns out that is enough to make payment on a $130,000 house in my area.(2) However, the houses in my area that I have my eye on run $150,000. Darn – I’m *this* close to being a homeowner!
I pay a marginal federal income tax of 35%. (3) This means that I need to earn $1,000 to pay the $650 I pay for rent: $1,000 – 35% ($350) = $650. If my tax rate were lower, I could afford to pay more, since I wouldn’t be paying that money to the IRS, but keeping it.
The brilliant idea: the IRS will allow you to deduct the interest expense portion of your mortgage payments from you taxable income, thus leaving you more money that you can put toward a mortgage – meaning, you can now pay more money to the bank in order for them to buy a housde for you, which you then purchase back from the bank over 30 years.
How’s that work? At current rates – around 4% – interest makes up about 70% of the house payments in the early years of the mortgage. The value of not having to pay federal income tax on that interest is therefore 35% of 70% of $650 – about $160 per month. So, at least in the early years of the mortgage, you can now afford to pay $810 per month toward owning a house.
$810 will buy you a $170,000 house, not just the $150,000 house you had your eye on. Woo hoo! Let’s say you buy the slightly better house. Now, instead of paying a landlord $650/month to rent, you are paying the bank $810/month to own your own home.
And thus, from the proponents’ side, the story ends happily – families that could not afford to buy a house now get one. Sure, the IRS is out the $160 per month which they, in their tender mercy, will need to make up someplace else – but let’s not bicker about who killed who – this is a happy occasion!
Follow the Money: Mortgages
But, alas! If you are cursed with a broader view of reality, you might start to wonder: what about the the other people involved? What about the next home buyer, home seller and banker?
Let’s assume this whole tax deduction of mortgage interest just went into effect, so that our buyer above is the first person to take advantage of it.
What about Act II? Well, let’s see what happens:
Buyers: all our new home owner’s friends and neighbors find out about how he could afford a nice home, and and are tempted to imitate him. Some do immediately, marching down to the bank to get a mortgage; others just file it away – home buyers now know they can pay more for a mortgage than they can pay for rent. Very quickly, this information becomes part of the universally known background against which people buy and sell homes and banks lend money.
Home sellers now know that there are going to be more people in the market with more money to spend on what they are selling.
Banks know that they will be able to build larger mortgage portfolios as buyers come into the market – this one is a little tricky, we’ll save it for last.
Even the most lemonade-stand level economic understanding can tell you what will happen next:
1. Since homes take time to build, the prices on existing homes will go up as there are more people with more money wanting to buy them;
2. People will be motivated to build homes to sell – at the prices that buyers seem willing to pay. So, in our example, the builders aren’t going to build $130,000 homes in our area – if they want to sell to people like the buyer in our example, they will build $170,000 homes, since that is what the buyer bought.
3. Some people who own homes bigger than what they need or want will consider selling them – but only at the higher prices. In other words, selling wan’t appealing at $X, but becomes more appealing at $X + whatever, until whatever hist the point of being irresistible.
4. These higher prices will lock some people out of home ownership – say, somebody who could afford only $500/month rent, and now can afford a $650/month mortgage payment with the interest deduction – he could have afforded a $130,000 house in our area – except there aren’t very many, if any, houses for sale at that price any more.
So: over time – and not decades, but a year or two – home prices go up to absorb the additional money now available to buy them. Existing home prices go up. And new homes get built to sell at the levels that people seem willing to pay – and those levels are higher because of the tax incentive.
Here’s the problem: I think, when I favor the deductiblity of mortgage interest, that I’m subsidizing home ownership – but am I? Let’s follow the money:
1. New home owners: Well, if I really could never have afforded a home without the tax deduction, then I get a home I would have not otherwise had, then I’m a winner, just not on a cash basis It’s a more expensive home than perhaps I should have bought, but what could I do? Prices keep going up. In any event, the money on any reasonable time scale, flows away from me.
Nope, not really helping the new home owner except in hypothetical cases – in the real world, prices reflect the added purchasing power created by the tax deduction – the first time buyer just pays more. (4)
2. Existing home owners: If I sell, I now make a lot more money! BUT – only if I don’t buy another house, which is also likely to be lots more expensive and eat up any profits. Even then, if I keep my profits, I’m likely going to get taxed on them.
Nope, not really helping the home sellers, except in those cases where I’m selling out and retiring or something like that. Money does not flow away from me, exactly, but it hardly flows to me, either.
3. New home builders: I sell homes – money flows to me. If I can keep my margins up, I make more money selling more expensive homes. (A 10% margin on a $100K home is $10K, but $20k on $200K home…)
Winner #1! Home builders win, as long as overall demand for homes does not decrease more than the dollar values of the margins increase.
4. Banks: Let’s see – before, I couldn’t lend to our buyer above, but now I can! Also, I can lend him more money – not just what he needed for the $150K home he was originally looking at, but for the $170K home he eventually bought! Yea, me! So even if the total number of home sales doesn’t go up, as the value of the loans increases, my revenue increases, too!
Winner #2, and the big winner: Banks.
Taxpayers/IRS: While there’s probably a Keynesian or 10 lurking under ever desk and trash basket who will try to sell you on what a great idea all this is short to mid term (5), the simple inevitable math says the IRS is using taxpayer money to subsidize banks and home builders, and that this particular wealth redistribution exercise may or may not in itself result in more homeowners, it sure as death and taxes will result in wealthier banks and home builders. And we’re going to have to make up that revenue from somewhere…
Not a winner.
Conclusion: The mortgage interest tax deduction transfers tax money to banks and home builders. There’s no reason to believe it encourages home ownership, as its one inevitable result is to raise home prices.
Once the market (that’s you and me in our capacity to buy stuff) recognizes the increased purchasing power the tax deduction of mortgage interest has created, prices rise enough to absorb that increase, and we reach a new sort-of equilibrium, price wise. That’s where we’ve been for ages now – no first-time home buyer is really being helped out by the tax deduction, rather, he’s just given the privilege of buying what would be an overpriced house in a market that lacked the the tax deduction.
Follow the Money: Universities
If you followed the last discussion, it should be clear that federal student grants and loans are not subsidizing the students, but the Universities and, again, the banks. Following the money, because demand (6) has been artificially inflated – students and their families have more money to spend on education because of the grants and loans – tuition has been likewise inflated.
My old school – St John’s College, Santa Fe – gave me a perfectly wonderful education, at about $6K – per year, all in, back in the late 70s. Now? Over $50K/year all in. That’s more than double CPI (Consumer Price Index, the go to measure of inflation).
What’s going on? Well, from a purely economic point of view, my old school, which could probably get along famously on $30K or so a year tuition (7), would see charging less as bad marketing and simply leaving money on the table – all the other (well, almost all the other) elite colleges charge that much! If we don’t we’ll look second rate!
So the campus, which was perhaps a little Spartan but was perfectly serviceable back in the 70s, is now very nice. Lots of pretty new buildings. I hope the teachers and staff are paid well.
And my school is hardly an exception – schools now have all sorts of luxuries unrelated to learning anything, from gourmet dining to elite workout facilities (8). Not that these are bad, just not anywhere near the core of getting an education (9).
Following the money:
1. Students and their families: Ha! The subsidized money all flows away from them, and, worse, tends to put them deep into debt. So, no, the grants and loans merely serve to inflate the prices paid, not the students.
Not a winner.
2. Universities and colleges. Their prices expand to absorb all the available demand (money). Those grants and loans all flow right to them.
Winner! And what’s more, they get to look kind while they collect the money and plunge you into debt. Nice work if you can get it.
3. Banks. Well, on those kinds of student loans where they banks are shielded somewhat from default, they win. I don’t know nearly enough about how this all works to say for sure, but I suspect the banks come out ahead in the long run – otherwise, they’d be working harder to fix it so they do.
Winner, with a caveat – I don’t if they win big or all the time.
4. Taxpayers/IRS: Let’s see – federal and state money spent so that schools can charge way more tuition, room and board, and crank out culturally illiterate and innumerate grads many of whom will default on their loans, some of whom will take to the streets demanding the government do something about their inability to get a cushy job with a woman’s lit or gender studies degree for which they went $50K in the hole? I think we can call that a loss.
1. That’s a Hegel joke, funny to nobody but me. Hey, It’s my blog, I can be lame if I want.
2. ‘My area’ being the township of Simplified, county Example, land of This Isn’t a Math Test
3. We’re simplifying here, although what I’m saying is pretty close to what really happens. Just in case we all don’t get this: nobody pays 35% federal income tax on their first dollar earned, nor their $20,000th earned – the ‘progressive’ tax taxes later dollars more than earlier dollars, until, at some point, you hit 35% – at which point, you get a tax adviser, or set up a 401(k), and take other steps to reduce you overall tax bill, for the same reason you don’t go shopping to find the highest price, but the lowest. The marginal tax rate is what you pay on whatever dollars you earn after you reach the highest rate you will pay.
4. Personal experience: 20 years later, we are living in our ‘starter home’ – home prices appreciated faster than my ability to afford them, so we were pretty much stuck where we are. Not complaining – hey, I like out house – just pointing out that one common experience is to see home prices in one’s neighborhood increase, yet, as a homeowner, not see your own wealth increase, since you’d need another home were you to sell…
5. In the long term, we’re all dead.
6. ‘Demand’ – I keep using that word! – means nothing more than ability and willingness to pay.
7. That’s about what Newman List colleges charge to provide a similar education – one of the non-Catholic reasons I love them and am sending kids to them.
8. And diversity officers, and studies departments, which are evil – but that’s another rant.
9. As if colleges and universities are set up to educate people! I slay me! Yet another rant.