A possible extension of the first-time homebuyer tax credit is one of the hottest issues right now, as lawmakers must decide whether drawing out the housing fantasyland is worth the tremendous cost of the program.
They shouldn’t. It’s a silly idea, one that’s way worse than Cash-For-Clunkers.
Self-Evident explains it well:
Suppose one day the government decided to give $1 to every person who buys a screwdriver. What would happen?
The immediate effect would be to increase the price of all screwdrivers by $1. Why? If the going rate for screwdrivers is (say) $5, then that is what someone who actually needs a screwdriver is willing to pay. (Put another way, that is the “economic utility” of a screwdriver. Put yet another way, that is the “market clearing” price that balances screwdriver supply with screwdriver demand.) If you pay $6 for a screwdriver and get a $1 rebate, from your point of view that is identical to simply buying the screwdriver for $5; either way, you are parting with $5 and getting a screwdriver, which you do because $5 is the screwdriver’s economic value to you.
Any idiot can see that this hypothetical government policy is not a gift to screwdriver buyers; it is a gift to screwdriver sellers. That gift would be shared with buyers only to the extent that it encouraged the production of screwdrivers in excess of natural demand.
Which brings us to the first-time home buyer tax credit, where the government reimburses buyers 10% of the price of the house or $8000, whichever is smaller. By the screwdriver analogy, this should have the simple effect of increasing the price of every starter home by $8000, right?
Wrong. Nobody buys a starter home with cash. The tax credit does not add $8000 to someone’s capacity to buy a house; it adds $8000 to their capacity to make a down payment. Maybe they take out a loan with 20% down. Or maybe they get an FHA loan with 10%, 5% or even 3.5% down. So the tax credit increases their purchasing power by $40k (20% down) or $80k (10% down) or $160k (5% down) or more.
Thus the net effect is twofold:
- Increase the price of all starter homes by $100k or more
- Increase the supply of houses
Is the problem with the housing market too little supply? Because that is the only “problem” this tax credit is solving. Read the whole thing >
Disagree? If it weren’t contributing to the supply of new homes, why is the NAHB (Nation Association of Home Builders) the primary advocate of its extention? It’s cause the program is causing more homes to be built, which is ridiculous, since not long ago, some were advocating destroying houses, and for most homeowners new supply is the last thing they want to be seeing.
It’s too bad normal homeowners don’t have the ability to organise, since they clearly should be against this short-sighted measure.