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Suburbanization and Tax Policy

The federal government has also contributed to suburbanization through tax policy. If you own a house, you can deduct from your taxable income both interest on the mortgage and property taxes on the house and the lot. If you rent a house or an apartment, you implicitly pay mortgage interest and property taxes because the landlord must cover these taxes through the rent. However, you cannot deduct these expenses from your taxable income. This favorable treatment of the owner vis-a-vis the renter creates a powerful push toward homeownership.

There was no spatial intent to this favorable tax treatment. One can take advantage of it just as well by buying an apartment in a high-rise condominium or cooperative in the city as one can in the suburbs. But because most of the land available for new construction is in the suburbs and exurbs, the net effect is deurbanization.

One should not underestimate the force of this favorable tax treatment acting year after year. For 2012 the federal government's Office of Management and the Budget (OMB) estimated the federal government's revenue loss (tax expenditure) on mortgage interest deductibility at $99 billion and the loss on local property tax deductibility at $25 billion.

Even that is not the end of the story. Since the Taxpayer Relief Act of 1997, a couple selling their house can exempt up to $500,000 of capital gain (basically, what they sell the house for minus what they paid for it) from federal taxation. For 2012 that tax expenditure was estimated at $35 billion.27 The three tax expenditures, totaling $159 billion, have a huge effect on people's decisions about whether to buy or rent and how much housing to buy. To the extent that the tax deductions increase the demand for owner-occupied housing, they also have a substantial effect on the price of housing.

The homeowner tax deduction has strong political support from homeowners who are able to benefit from it (you must be able to itemize your deductions in order to do so) and from the real estate industry because it increases the total demand for housing. The Obama administration has suggested scaling it back by limiting the maximum deduction that can be taken. The argument is that most of the tax expenditure goes to wealthier people because they tend to own more expensive homes and because they are in higher tax brackets and thus a given amount of deduction is worth more to them. But regardless of any modifications, it seems unlikely that the deduction will disappear entirely.

For at least four decades planners and others concerned with housing markets have noted that the homeowner's deduction tips the housing market toward ownership. Renters pay property taxes implicitly because it is a cost their landlord must cover. It is periodically suggested that the deduction be extended to renters to level the playing field. Although that idea makes good sense, it has never gained much political traction.

But Is It Planning? The question is whether one should refer to the federal government's actions just described as "planning." In the matter of restructuring mortgage lending there was, in a loose sense, a plan. The goal of the plan was to promote homeownership. In this regard the federal government was highly successful.

The issue is less clear with regard to tax treatment. Provisions exempting interest and local taxes have been part of the IRS code since its inception. The Tax Reform Act of 1986 took away the exemption on most other local taxes and most other types of interest payments (for example, interest on credit card debt or on a car loan is not tax-exempt). But Congress left the homeowner treatment untouched. One reason was that trying to eliminate it or scale it back would have provoked a political firestorm, as about two-thirds of all occupied housing units in the United States are owner occupied. Some feeling in Congress that homeownership was an important national goal to be pursued through continued favorable tax treatment was probably also a factor.

The idea that the widest possible homeownership is necessarily a good thing has changed in the last several years. The most obvious reason in that homeownership has proven to be a financial disaster for many millions of people. A more subtle insight is that widespread homeownership makes labor markets less flexible because someone who cannot sell or rent out his or her home is often locked in place and cannot move to take a job somewhere else. In that way, widespread homeownership may at times contribute to higher unemployment rates. Thus it will not be surprising if Congress someday decides to take a serious look at the tax treatment of owner-occupied housing.

 
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