"Tax Entitlements" for Housing: When Tax Expenditures Finance Inequality Part 1

“The most important difference between the United States and other rich countries is not how much it transfers, but rather how, through whom, and to whom transfers flow.”

-from Wealth and Welfare States: Is America a Laggard or Leader? by Irwin Garfinkel, Lee Rainwater, and Timothy Smeeding

“Big Government” is getting a lot of headline space this year. Most of the noise (most of the words don’t rise to the level of debate) is about the cost of government growth, the dangerous levels of debt, and the many aspects of our lives the government now touches.

The book quoted above points out that, if education is included with health care, housing and retirement benefits, the U.S. welfare state is not so different in size from that of other developed countries. However, there is a difference in the distribution of benefits.

Picking up the discussion on tax expenditures (or what I’m dubbing as “tax entitlements” from a previous posting), federal financial assistance in housing illustrates how strongly distinctions in domestic spending are made between economic classes. Aid to low income families is not only less generous when compared to aid to upper income families, but the assistance is less reliable, more bureaucratic and politically vulnerable the poorer you are. Those sharply distinct methods have led to radically different outcomes for low income renters versus upper income homeowners: for renters, underfunded, under-maintained, stigmatized housing projects  while for homeowners, overpriced, over-sized single family suburban tracts that periodically experience finance-enabled booms and busts.

The first class distinction you need to know about when discussing tax breaks is that they are only directly useful to tax payers. Low income families can’t use tax deductions because they don’t itemize deductions when filing their tax returns and because of features introduced into the code by the Tax Reform Act of 1986, investment-related tax credits are really only useful to tax paying corporations. So how and why are tax credits used by congress to build low income housing and how do they compare to the tax breaks given to homeowners? First some history.

All the History of Housing Policy you need to know

In common with other federal social programs, federal intervention in the housing market started with efforts to recover from the Great Depression. A simplified but useful way to think about the federal approach to helping families with housing is to follow the development of a simple financial transaction - the so-called traditional 30 year amortizing fixed rate or prime home loan. Until the Depression, most home mortgages were short-term loans that had to be rolled-over every five years or so. When the banking system collapsed, a foreclosure crisis followed the inability to refinance.

Congress encouraged the development of the saving and loan industry by passing the Federal Home Loan Bank Act in 1932. This legislation set up the  Federal Home Loan Bank system that provided funding for long term, self-amortizing (as opposed to short term loans with balloon payment) home loans. The Homeowners Refinancing Act created the Home Owners' Loan Corporation (HOLC) in 1933 to refinance homes in order to avoid foreclosures by making available self-amortizing long term mortgages to replace the short term balloon payment mortgages that were coming due in early stages of the Great Depression. The bank could finance the loan with deposits with a cost that was largely fixed by federal regulation (regulation Q).

The Federal National Mortgage Association (Fannie Mae) was established in 1938 as a federally chartered government-sponsored enterprise to provide liquidity in the mortgage market by selling bonds and then, with the proceeds, purchasing mortgages from lenders, primarily savings and loan associations and commercial banks. Fannie Mae was privatized 30 years later and joined by Freddie Mac two years later to give it some competition.

This tightly wrapped package started to unravel with the high inflation of the 1970s when interest rates could no longer be held down to the level that banks were engineered to assume. Congress tried to adjust to the new conditions with step-by-step deregulation of the system. Some observers suggest that the loosening-up that started in 1980 accumulated speed and ran off the tracks twice: the Saving and Loan crisis of the late 1980s and then the recent “sub prime” collapse.

Critical to the story line: this government model did not apply to all Americans. Redlining, or the practice of delineating neighborhoods where banks would not lend became an operating convention of the prime mortgage industry. It originated with the racial rhetoric of the management handbooks of the HOLC and found a secure home at Fannie Mae and the private banking industry, assuring that the traditional mortgage was almost exclusively available for white families. 

By the 1960s, the effects of preferential treatment for segregated suburbs were clear to most.

Families that were not covered by the prime mortgage umbrella were sent on a separate track called subsidized rental housing: a.k.a., the projects. The Housing Act of 1949 greatly expanded the federal role in building low income housing that had started slowly in 1937.

Who gets the “tax entitlements?”

Both low income renters and upper income homeowners are on the receiving end of special federal tax treatment to assist with their housing needs. The following graphs from the Congressional Budget Office gives an idea of the difference in generosity.

Federal Support for Housing, 2009

(Billions of dollars)

Sources: Congressional Budget Office (for spending amounts); Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2008–2012 (2008) (for tax expenditure amounts).

However, there are more interesting differences than the volume of dollars available. 

To be continued in "Tax Entitlements for Housing: When Tax Expenditures Finance Inequality Part 2"