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The Trouble with the First Time Buyer Tax Credit

(10-28-09) There's been a rush of real estate activity, very similar to that which occurred at the conclusion of the cash-for-clunkers program, to complete purchase transactions before the wildly popular $8,000 “first time buyer” tax credit comes to an end. The program has made a difference by bringing sales forward and creating an environment of deadline-related urgency, though arguably a number of the affected purchases may have occurred without the tax incentive. Here is an overview of some of the problems associated with the tax credit:

The Cost, Including the Opportunity Cost

According to the IRS, nearly 1.4 million people have taken advantage of the first time buyer credit and from this total, approximately 350,000 sales can be directly attributed to the credit, according to the National Association of Realtors. Therefore the (estimated) real per transaction cost to taxpayers is 1.4MM credits used multiplied by the amount of the credit $8,000 (assuming the max credit amount was used), then divided by 350,000, which results in $32,000 for each purchase transaction that would not have other wise occurred without the presence of the tax credit. Wouldn't $32,000 be a better long term taxpayer investment if spent on student loan financing as opposed to a temporary fix for housing? When the credit is extended, or worse expanded, the real per transaction cost will likely go even higher.

The Fraud

The Associated Press reported information released from the Treasury Inspector's report indicating that 74,000 taxpayers who had claimed the first time buyer credit, amounting to some $500 million in claims, had been previous homeowners. Whether or not these taxpayers qualified under the program remains an open question, the program defines a “first time buyer” as someone who has not owned a primary residence in the previous three years. Which means that even real estate speculators who own investment property, rather than an owner occupied primary residence, could qualify under the program. Also, for the tax year 2008, some 19,000 returns had claimed the credit for homes not yet purchased, totaling some $139 million in claims. Claims for the tax credit were also made fraudulently in some 580 cases involving minor children ineligible to legally acquire property let alone qualify for the tax credit. Controls and safeguards under the program, as is the case with most government programs, are severely lacking.

Stealing Sales from the Future

Just as the Cash-for-Clunkers program proved, once these tax incentives are removed, the purchasing of the incentivised item will cease. In essence all that is accomplished is stealing transactions away from the future. The previously projected November 30th deadline for the first time buyer credit has been the spark for real estate activity in recent months and as a result, activity will slow once the incentive is ultimately removed and prices will again soften with a new wave of foreclosures and no new buyers.

Replacing Wall Street's Misguided Financial Engineering with Washington's Misguided Economic Engineering

At some point the economy is going to have to stand on its own feet, the government cannot forever inject taxpayer money, robbing from future generations, to support the bad decision making of the present one. The market should pick the winners and losers and restructure without the corrupt short-sighted CEOs on Wall Street making the call or Washington legislator's who are unduly influenced by lobbyists making these decisions for Americans. The U.S. economy is dependent on consumer spending for 70% of its GDP and therefore needs a middle class with middle class jobs and wages supporting it. For decent jobs to return, private capital and investment need to flow in an environment free of massive government created distortions.

Not Permitting the Needed Correction in Housing to Occur

The U.S. economy and tax system is already generously geared towards favoring real estate, how many more incentives are truly needed to prop it up? Both monetary and fiscal policy heavily promote real estate, from the massive support of the FHA, to bailing out the banks and GSEs, Fannie Mae and Freddie Mac, to providing the very foundation for mortgage backed securities and outright purchases of treasuries to keep rates at record lows. On the tax side, from the mortgage interest deduction to the capital gains exclusion, what more should be done to promote homeownership in America. It may be time to let the chips fall on all bad housing bets.

Setting in Motion More Future Mortgage Defaults (AKA Remember the Jobs Problem)

What happens when many of these so-called first time buyers lose their jobs or can no longer afford to make their mortgage payments? Until the job market stabilizes, isn't buying a home a risky proposition for all but the most secure in their jobs and presumably not a younger first time buyer at the beginning of their career, potentially needing to relocate in the process of seeking a job? The Federal Housing Administration (FHA) is already taking on alarming levels of mortgage insurance risk, why add on to the pile putting taxpayer dollars further in jeopardy.

Nancy Osborne, ERATE.com Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.