econ 135 fall08 lecture10

econ 135 fall08 lecture10 - Urban Economics - Lecture 10...

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1 Urban Economics -- Lecture 10 Public Policy Toward Housing How does the government subsidize housing? How do these subsidies affect urban form? How do subsidies affect the decision to own versus rent? About 66% of US households own their own housing. 1. Subsidies to owner-occupied housing: Return from owning your own house = PV of future housing services + PV of capital gains on the house - PV of [mortgage interest cost + lost return on equity in the house + property taxes + cost of depreciation/maintenance]. Look at this equation term by term:
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2 The value of housing services is the rental value of the house each year, discounted to the present. Homeowners both pay and receive this value, but don’t pay taxes on it. (In contrast, owners of rental property must pay taxes on rents they receive.) This is the largest tax subsidy to owning. Capital gains are the increase in the value of the house while the owner owns it, received when the house is sold. They are tax free up to $500,000. The mortgage cost and lost return on equity represent the value of the capital tied up in the house—including borrowed funds (owner must pay interest) and the owner’s own funds (owner loses the return from investing the funds). This cost is incurred each year. Depreciation is the reduction in value due to the property aging.
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3 For taxpayers who itemize on their taxes, the cost of mortgage interest and interest on home equity loans and property taxes are tax deductible. This reduces their cost by a factor of (1- t), where t is the household’s marginal tax rate. Only about 1/3 or ¼ of all HH itemize (mainly rich people). Since income taxes are progressive, the rich get higher housing subsidies than the poor per dollar of expenditure. The government subsidized the creation of a secondary market for mortgages, which increased the supply of long term, fixed rate mortgages. Most mortgages are now for 30 years, in the past only 10 or 20 year mortgages were available. “Fannie Mae” (Federal National Mortgage Association) and “Freddie Mac” put mortgages together in blocks and sells shares of the blocks on the bond market. All have the same terms.
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4 Effect of these subsidies on owner-occupied housing: They reduce the cost of consuming a bigger house. One study estimated that housing consumption increased by 14%. Subsidies are larger for rich people. They probably also encourage people who would become homeowners anyway to shift from renting to homeowning earlier. But they have little effect on the decision to become a homeowner for people who are low income, since they don’t generally itemize even just after they buy. (Note: the textbook disagrees on this.) NYT article on the 2007 mortgage crisis.
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5 Should homeowning be subsidized and, if so, how? Tax Reform Commission recently recommended eliminating the mortgage
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This note was uploaded on 06/30/2009 for the course ECON 135 taught by Professor Staff during the Spring '08 term at UCSD.

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econ 135 fall08 lecture10 - Urban Economics - Lecture 10...

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