My testimony to Senate Finance Committtee on Housing and Tax Reform

I testified today.  Here is how the written testimony opens:

Chairman Baucus and Ranking Member Hatch, I want to thank you for the opportunity today to present my views on the issue of housing and tax reform.  My name is Richard Green, and I am a professor in the School of Policy, Planning and Development and the Marshall School of Business at the University of Southern California.  I have published extensively on the issue of the Mortgage Interest Deduction, and in particular published a paper co-authored with Dennis Capozza and Patric H. Hendershott on housing and fundamental tax reform for the Brookings Institution[1].

My general philosophy is that the tax code should be as broad-based and efficient as possible, while maintaining vertical and horizontal equity to the best extent possible.  I find many of the ideas proposed by Robert Hall and Alvin Rabushka to be quite appealing, and to me, in an ideal world, we would have something quite similar to the tax code they propose, albeit with an earned income tax credit added.  That said, we are manifestly not in an ideal world, and issues of transition matter.  As I wrote in 1996, a rapid change in tax policy could have a traumatic impact on the economy, so it is important that congress phase in any major changes to tax policy involving housing.

That said, I have long thought that the Mortgage Interest Deduction is a residual of the 1913 tax code, accomplishes little that its supporters claim for it, pushes capital away from plant and equipment toward housing, and benefits high income (although perhaps not very high income) households more than the remainder of the country.

I will divide my remarks into 8 parts; (1) I will argue that the Mortgage Interest Deduction is a residual of the 1913 tax code, and was not created to encourage homeownership; (2) that those on the margin of homeowning get little-to-no benefit from the Mortgage Interest Deduction, and that the policy therefore does little to encourage homeownership; (3) that the Mortgage Interest Deduction does encourage those who would be homeowners anyway to purchase larger houses than they otherwise would; (4) that even in the absence of the Mortgage Interest Deduction, owner-occupants receive a large tax benefit; (5) that phasing out the Mortgage Interest Deduction would encourage households to pay down their mortgages more quickly, and would therefore encourage households to rely less on leverage; (6) household deleveraging would lead to greater market stability, but would also mean that the revenues generated by the elimination of the deduction would be smaller than static estimates suggest; (7) at a time when the housing market remains quite weak, it is important that the Mortgage Interest Deduction be phased out carefully; (8) that if we do wish to encourage homeownership via tax policy, a targeted, refundable credit would be more effective than the current Mortgage Interest Deduction.

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[1] Dennis Capozza, Richard Green and Patric Hendershott (1996), Taxes, Mortgage Borrowing and Residential Land Prices in H. Aaron and W. Gale, ed. The Economic Effects of Fundamental tax Reform, Washington, DC Brookings Institution Press: 171-210

There is no reason to be upset with BofA for its new debit-card fees.

The ATM Debit-card fee is transparent and easy to understand.  This is far preferable to the spate of fees (such as overdraft insurance charges) that were opaque and confounding.  If Bank of America wants to charge for a service, they should be free to do so. 

Will the private market step in?

Conforming loan limits in San Berardino and Riverside Counties in California will drop from $500,000 to $417,000 tomorrow; in LA and Orange Counties it will drop from $729,750 to $625,500. 

So we have a natural experiment in "crowding in."  Will the private lending sector fill the gaps?

Austerity is a problem, but so is fear

Paul Krugman this morning argues that fear of fear is phony.  He is almost certainly correct that fear is not the number one problem at the moment--if I had to pick a number one issue, it would be austerity measures at the state and local levels of government.  Tracy Gordon of Brookings has a nice picture:

 Cuts in state and local government jobs (police officers, school teachers, firefighters, DMV workers) are putting a drag on employment growth.  Moreover, this picture understates the problem, because total compensation to many state and local workers has been cut.

But I do think fear is part of the problem, at least in one sector of the economy.  It seems to me that there are business opportunities in lending that are going unanswered.  The pendulum for underwriting has swung so far to caution that according to the Flow of Funds Accounts, net lending declined in the second quart of 2011.  More specifically, net bank lending dropped by $181 billion on an annualized basis in the first quarter and by $129 billion in the second quarter.  Net lending is the difference between volume of new loans and volume of repayment of old loans. I do find it plausible that one of the sources of the tight lending environment is a fear of regulators.

One more point.  if it weren't for lending by the monetary authority, net lending in the second quarter would have fallen by $860 billion on an annualized basis.

My friend (and co-author) Andy Reschovsky wins Steve Gold award

It was nice to read about it this morning:

University of Wisconsin–Madison economist Andrew Reschovsky will be honored in November with the 2011 Steve Gold Award, which recognizes a person who has made a significant contribution to public financial management in the field of intergovernmental relations and state and local finance.

The Association for Public Policy Analysis and Management, the National Conference of State Legislatures and the National Tax Association give the award each year in memory of Steve Gold, an active member of all three organizations whose career and life tragically were shortened by illness.
"I knew Steve Gold, which makes receiving this award even more meaningful," says Reschovsky, a professor of public affairs and applied economics in UW–Madison's La Follette School of Public Affairs. "As a public finance economist, Steve believed his role was to communicate to policymakers about research and analysis. His emphasis on the link between scholarship and practice and on policy-oriented work on public finance has very much influenced my career."

Boston Fed President Eric Rosengren on the need to facilitate refinances (h/t Kurt Paulsen)

He says at a meeting in Stockholm:

There are several proposals that attempt to facilitate refinancing for homeowners who have been negatively impacted by the drop in housing prices. These proposals do face hurdles, including how to address private mortgage insurance and second liens. However, a program that made it possible for many homeowners to refinance, even if they were upside down, would likely provide significant reductions in mortgage payments to individuals who are likely to have a relatively high propensity to consume. Clearly getting more money into the hands of homeowners who would spend it could help to fuel GDP growth. This would reduce one of the impediments to a more significant effect from the monetary policy actions taken to date.

I hasten to add that there is already a government program to allow underwater borrowers to refinance, the Home Affordable Refinance Program (HARP). This program allows underwater borrowers with Fannie Mae or Freddie Mac loans to refinance at lower rates. Unfortunately, the program has helped fewer borrowers than was originally hoped. Fed Governor Betsy Duke outlined some of the potential reasons why, in the talk I mentioned earlier. They include loan-level price adjustments (LLPAs) that raise interest rates for many borrowers and thereby reduce the benefit of refinancing; originator worries about “buybacks” forced on them by Fannie Mae and Freddie Mac; junior lien-holder resistance to re-subordinating their loans; and mortgage insurance policies.

The Federal Housing Finance Agency (FHFA) is now investigating whether there are ways to enhance the program to benefit more borrowers.[Footnote 15] As this work proceeds, I hope the FHFA considers dropping or reducing LLPAs in cases when a GSE loan is refinanced into another GSE loan. Such a refinance actually reduces the GSE’s credit risk (they already guarantee the existing mortgage and the homeowner will be able to take advantage of lower rates, freeing up cash flow).

Am I posting this because I agree with it?  Yes. 

Hard Choices

Los Angeles (and other large cities) have food deserts--places with limited access to fresh, healthful, relatively inexpensive food.  Low-income people living in food deserts are at a particular disadvantage, because they can't afford cars, and therefore often do not have access to supermarkets. A common hypothesis is that poor kids eat unhealthy food because they don't have access to healthy food.  (I think this is only partially true--kids also eat unhealthy food because they like it.  For that matter, I still love McDonald's fries, I just try to limit my intake, and am in part able to because I have access to better alternatives).

Tesco's Fresh and Easy, a chain that develops and operates small grocery stores that feature fresh fruit and vegetables at reasonable prices, has decided on a business strategy of locating in food deserts.  This is potentially a great thing for kids who live in these places (especially if Fresh and Easy can figure out how to take WIC vouchers).  But this begs the question of how they are able to sustain such a business model.  Two answers present themselves--they are a non-union shop, and they rely heavily on automation.  Specifically, Fresh and Easy features self check-out, and so the store doesn't have to hire checkers.   Self check-out also makes it hard for Fresh and Easy to accept paper certificates, such as WIC vouchers, as payment.

So the cost of Fresh and Easy is that it may drive down wages for grocery workers a bit, and it may reduce employment for grocery workers.  The benefit is that it gives low-income children access to reasonably priced, good quality, fresh foods.  My personal social welfare function says to me that feeding kids inexpensively and well dominates most other considerations, but let's not pretend that there isn't a trade-off.