The Impact on Housing and Homebuilding
July 3, 2008 · Filed under: Education
A new study was released from the Baker Institute For Public Policy at Rice University - The Impact of H.R. 25 on Housing and the Homebuilding Industry (thanks Hayden for the link).
Abstract: This report examines the macroeconomic and transitional effects of implementing a specific type of consumption tax reform—the national retail sales tax known as the FairTax, as specified in H.R. 25—with a focus on the effects of such a reform on the housing sector, including reform-induced reductions in the prices of existing housing. The analysis is conducted within the context of a dynamic overlapping generations computable general equilibrium model that includes a corporate sector that produces a nonresidential composite good as well as noncorporate rental housing and owner-occupied housing production sectors and allows for the costs of adjusting all capital stocks in response to the enactment of the reform.
The study also includes an analysis on the tax rate, which they put at 28% inclusive.
25 Responses to “The Impact on Housing and Homebuilding”
Hey... First poster on this one?
Reading the first few pages of this doesn’t look good for the FairTax. I have definitely not had time to read the whole thing and have no idea when I will. The things I noted in the first few pages is that this study claims to implement the FairTax in it’s “pure” form. The only alteration made was to factor in the necessary increase in government spending to account for the assumed “100% increase in prices of the tax exclusive rate”. Honestly this does make sense to me, but I could be missing something here.
Hayden made the comment that the individuals involved with this study are “supporters” of the FairTax. Reading the first few pages does not lead me to this conclusion. The language and characterization of various aspects of the FairTax in the first few pages sound as if this is written with a distinct negative slant towards the FairTax.
I have heard FairTax proponents (not on this board, but you know who I mean) routinely claim that the FairTax plan was developed from studies done at Harvard, MIT, Boston University, Stanford and Rice. Here’s a scorecard based on what we know at this point:
Harvard — Dale Jorgeson — does not support FairTax
MIT — Jim Poterba — does not support FairTax
BU — Larry Kotlikoff — supports FairTax
Stanford — ?? (presumably someone from Heritage Foundation) — supports Flat Tax, not sure about FairTax
Rice — Zodrow/Diamond — I had thought that Zodrow was an early supporter of the FairTax. But maybe Scott is correct and they don’t support the FairTax after all.
As someone in one of the Alice books said, “This is getting curiouser and curiouser.”
I’m still reading the tax rate section but one thing jumped out at me early. They maintained the Earned Income Credit and the refundable Child and Dependent Care Credit (48.9 billion). So while the rate is higher, they changed the progressivity (similar to the addition of a targeted rebate). Since these credits are always factored in an income tax system tax burden analysis, and never included in one on the FairTax, I find this an odd inclusion. Gale also did this. So next time we talk about a higher rate and use it to establish a tax burden distribution, we’ll have to include the effects of the Earned Income Credit and the refundable Child and Dependent Care Credit. Back to reading (this is killing my lunch break... thanks Hayden haha)
The major factor that I see in the rate difference is in regard to State and Local spending on education ($302.3 billion).
The state and local educational spending thing to me seems like a wash.
That is, if state spending is taxed under the FairTax, then FairTax base will increase, the FairTax rate will be less, but state and local taxes will need to increase to pay the FairTax.
On the other hand, if state spending is not taxed, the FairTax base will be lower, the FairTax rate will be higher, but state and local taxes will not need to increase.
So, as Hank has said all along, in order to calculate the true burden under the FairTax you need to do one or two things:
1. Totally exclude state and local goverment spending from the base, and calculate the FairTax from private consumption only. Or
2. Include state and local government spending in the base, but then provide an estimate as to how much state and local taxes will need to increase to pay the FairTax to the federal government. E.g., state and local taxes will increase by an average of 30% or whatever. Or
3. Some combination of the above, since currently educational spending is excluded from the tax base, but there is apparently some discrepency as to what would be classified as tax-free educational spending.
There’s an aspect to state and local government spending that has not yet been raised. Kotlikoff and company, out of conservatism, dismiss the dynamic effects the Fair Tax will have on the economy. They shouldn’t.
One of the major dynamic effects of the Fair Tax on the economy is the overall reduction in debt service costs due to the availability of capital. For state and local governments (particularly in New Jersey) these benefits are huge. They cut across education and non-education spending alike. They should be a major offset to increases in nominal state and local government costs due to the taxation of state and local governments.
~Jim
It’s important to note that for “K-Base” result in Table 1, Zodrow used Kotlikoff’s exact method but used actual 2006 numbers instead of Kotlikoff’s estimated 2007 numbers and came up with a 26.5% inclusive rate.
Jim — Can you please explain what you mean by “the overall reduction in debt service costs due to the availability of capital?” I’m guess I don’t understand why more capital would be available under the FairTax and why that would lead to a reduction in debt service.
Thanks.
I’m not sure about the “reduction in debt service”, but the increase in capital would be due to the removal of income and capital gains taxes. Basically, this would be based on the fact that individuals with vast sums of moneys stashed in off-shore accounts could bring these funds back into US based banks without any tax implications. This influx of money into US banks is I’m sure where this idea of increased availability of capital.
Scott — I have heard this argument before — that eliminating the income tax will lead to the repatriation of $12 Trillion held overseas — which sounds plausible on the service, but I’m not sure it’s really accurate.
In the first place, under current law, I do not believe there is any tax benefit whatsoever for holding dollars overseas. I mean, if you’re a billionaire and you’re holding a billion dollars in a Swiss Bank Account, there’s no reason why you wouldn’t simply convert that money into Euros. In fact, given the drop of the dollar the last few years, it’s likely that most billionaires in that situation have converted their off-shore dollars into Euros long ago.
If you assume the billionaire is not reporting the interest income he receives on the dollars he holds in Swiss bank accounts, so what? If he converted to Euros, he wouldn’t report the interest income on the Euros either.
So, I don’t believe our tax laws have anything to do with why there are so many dollars held overseas. If that’s the case, then switching to the FairTax isn’t going to make any difference in that respect.
So why are so many dollars held overseas? Mainly because the dollar has been the world’s primary currency for sixty years or so. Countries have held dollars as their primary foreign reserve (which they use to protect against the drop in the value of their own currency). Companies use dollars to purchase goods in the international markets, such as oil, which (I believe) can only be sold in dollars. (In fact, one of the big fears among US economists is that the Middle Eastern countries will start pricing their oil in Euros rather than dollars, which would mean that foreign companies and buisiness would not need so many dollars any more.)
In turn, the Middle Eastern countries need to invest those dollars somewhere. Europe wants to keep that money in Europe, so European banks started accepting dollar deposits decades ago (i.e., the so-called “Eurodollars”).
The bottom line is that I don’t think the reason so many dollars are held overseas has anything to do with our tax laws, so there’s no reason switching to the FairTax would bring those dollars home.
One final thought, why would we even want those dollars returned to America? As it is now, we have foreign governments, businesses and wealthy individuals essentially giving our goverment an interest-free loan by holding on to the dollars. Those foreign holdings of dollars partially props up the value of the dollar. If there was no longer any perceived need for them to hold onto those dollars, then the value of the dollar would plunge (even further than it has), inflation would skyrocket in the US, as would interest rates.
I might be wrong here, but if I am I would appreciate someone straightening me out. Thanks.
So, if there’s no advantage under current law of
According to Linder, Alan Greenspan stated it would take only months for this “12 trillion” to be repatriated back into U.S. banks where it could then be used to grow the economy. I’m not sure about the particulars of it, but Greenspan certainly holds some weight with me.
Morph –
I googled “Greenspan” and “FairTax” and the only citations I came up with to the $11 trillion assertion is your article in Wikipedia, in which you cite Linder!
Although Greenspan has spoken favorably of a consumption tax, there is no record in any newspaper article or elsewhere of Greenspan having said anything about repatriating $11 trillion.
With all due respect to Linder, he is the primary proponent of the FairTax in Congress and over the years he has made a number of unverifiable statements that “other people” were supposed to have said.
For example, he repeately said that the President’s Tax Reform Commission told him that the FairTax was the only tax plan that “untaxed the poor,” but in reality the Tax Reform Commission’s report totally trashed the FairTax and concluded that it would be highly regressive.
He also apparently the source of the claim that former Congressman Bill Archer said that 500 foreign businesses would immediately relocate their businesses to the US if the FairTax were adopted. Again, there’s no verifiable record of Archer ever having made that statement.
And Linder still claims in public speeches that under the FairTax workers will “keep 100% of their paychecks” while prices will drop on average of 22%, which has been proven false. (In their books, even Linder and Boortz have backed off that claim.)
My point is that Linder has a history of making exagerated and unverifiable claims about the FairTax, particular with respect to what “other people” think of the FairTax. If he is the only source for the claim that Greenspan believes that “$11 trillion in foreign-held dollars will be repatriated,” then that is not a credible claim at all. It would be easy enough for Greenspan to pick of the phone and call a reporter if he really wanted to make an on-the-record statement about the merits of the FairTax. (By the way, there a plenty of people out there who believe that Greenspan was the worst Fed Chairman in history and has ruined our economy for years to come, so even if he came out in support of the Fairtax there are a lot of folks who would feel that in itselff would be a good reason to oppose it.)
So, my question stands: Why do people think that $11 or $12 trillion dollars (or whatever the number is) that are allegedly behing held overseas will be returned to the US if the FairTax passes? What is the tax advantage for them to be currently holding that money overseas? And, would it even be a good thing if the money were returned to the states?
Morphh,
With all due respect to Alan Greenspan, as I have pointed out previously, this Fairtax claim that $12 trillion in offshore assets would come home is a bunch of nonsense. Unfortunately, my sources are back in my Florida computer, but as I recall, there is a study that confirms that there are something like $12 trillion held offshore, but those assets are not American owned. Only about $1.5 trillion is owned by North American wealthy individuals/corporations, and there are 23 countries in North America ranging from Panama to Greenland. I think the amount of US wealth held offshore is measured in billions, not trillions, and the study claimed that the lost revenue due to these offshore US holdings is less than $100 billion.
I’d also point out that the provisions of HR25, Sec 905 (I think?), make it very unlikely that any offshore holdings would rush back to our shores!!
I can’t understand the alleged Greenspan comment, but suspect that he is being misunderstood or misquoted. Perhaps you should try him again with all the details of just what the $12 trillion in offshore assets consist of??
Here is another article referencing a study (maybe the same study) by Diamond/Zodrow on housing. It’s sort of mixed.
http://www.nahb.org/generic.aspx?genericContentID=90964
On one hand it says the tax rate will be a few percentage points higher than the 23/30 rate and that there will be at least a temporary slowdown in home construction and home prices. On the other hand, it says that economic growth should be modestly higher under the FairTax which will, in the long run at least, mitigate the immediate problems.
So there’s something for both sides to argue about!
Like I said “According to Linder” - it’s up to each person to decide if they think it is a “credible claim”. As for my opinion, I don’t think Linder has shown himself to be a lier but like most politicians, he will certainly put his goals in the best light.
I have to say that I’m finding this particular research a bit unnerving. I really like the idea of the FairTax, but I am by no means a blind zealot. The points raised and benefits indicated in the FairTax books and other articles make this seem to be a great boon for our economy. Independent research such as this that SEEMS to genuinely refute these claims is for me a serious blow.
I truly hope that someone can legitimately discredit this research by pointing out specific flaws. This research claims that it takes the FairTax proposal as is, and if this is indeed the case and the assumptions made in the study are reasonable, this is very discouraging. I would love to see someone pick this part and point out any inaccuracies or debatable assumptions such that my faith in the FairTax can be fully restored.
I haven’t had a chance to read it yet, but it if suggests the FairTax would be bad for the economy, than it’s in small relation to the many that suggest otherwise. Even critic economist William Gale stated it would provide economic gains. The only critic study that I know of that showed a negative was the National Retail Federation study on the Individual Tax Freedom Act, but even that predicts that the economy will grow only 3% more in ten years than it would have under the income tax and that the increase in consumption will be 1.15% less in the first year relative to what it would have been under the income tax.
I can understand how such might effect the housing market in a negative way though. Currently the tax system plays favorites (social engineering) to housing. The FairTax could decrease the social incentive to spend more on homes in favor of savings, education, or other investments. If this is an issue, the question for me becomes “Why should we subsidize the housing industry?” Of course they’re going to cry about it... as will thousands of special interests that have their hand in the cookie jar. What we’d see is the pain created by returning to the free market after government intervention / manipulation. The government could still maintain some special handout to this section via a social program or transition rule (an expense).
We may be looking at the thought that if you untax savings, people are going to save more - which I think is a good thing (saving rates are way to low in this country). This will have an effect on certain consumption in the short term but will work itself into the market as investment capital.
Reading the conclusion, they do state that it would increase GDP and “generate significant overall macroeconomic improvement in both the short and long runs”. They then go on to discuss the particular transition issues on the housing industry, which some are good and some are bad. The values of existing rental housing would take a big hit. Special interests in the income tax code come in both favorable and unfavorable forms. It’s no doubt that removing some of them will hurt if no transition adjustment exists, which is essentially what this study seems to state with regard to housing.
I think that the general benefits of the consumption based tax are solid and pretty much widely accepted. The biggest concern I have with this is once again we have a rebuttal indicating the need for a higher tax rate than the proposed FairTax rate. This is one of my biggest concerns. The higher the rate ends up being, the more profound an impact I think it will have on the short-term economy. Furthermore, the higher the rate at implementation, the less likely it is that this could be implemented. The 28% inclusive rate is not a deal breaker for me, but I’m afraid that it would be for many.
I contacted Tuerck and Kotlikoff. Both said that they have not had time to read the study but hope to soon.
Here is my take on the “Rice Study”. Comments welcome!
Over the last few years, opponents of the Fairtax have relied on Gale, and the report by the Presidents Tax Reform Commission. Supporters of HR25 relied on Kotlikoff et al when discussing the revenue neutral Fairtax rate. (keep in mind that Kotlikoff et al spent most of 2006 trying to come up with a rationale that would support a revenue neutral rate of 23% as required by HR25. They failed and were reduced to talking about cutting non defense discretionary spending by a few percentage points in order to make the 23% rate work. The Fairtax never has been revenue neutral at 23%!!) Now, we have the recent Rice report which rationalized the differences between Gale and Kotlikoff and came up with a reasonable Fairtax rate consistent with the language of HR25.
The most important Rice input was to convert both Gale and Kotlikoff studies to a common base year of 2006. Gale extrapolated 2003 data over a ten year period, and Kotlikoff used 2007 estimates. By converting all studies to 2006 actuals, the Rice report was able to close the gap between Gale and Kotlikoff significantly. From that point on, the Rice team identified all other differences between Gale and Kotlikoff, and then provided their rationale for siding with either, or sometimes “splitting the difference”. The result would seem to provide an unbiased 28% inclusive Fairtax rate consistent with the terms of HR25.
The Rice team concluded that, although the rate would be 28%, that rate would clearly be a lower bound, conditional on enacting and enforcing all terms of HR25, a most unlikely scenario in their judgement!
The new 28% rate impacts several features of the Fairtax. (1) The cost of the prebate rises to $584 billion in 2006 dollars, and would be well over $600 billion if HR25 was enacted for 2009. As I’ve written before, this huge cash grant entitlement would be a budget breaker imho. (2) Retail prices will rise at the cash register by an average of 25%. Rice assumed that prices would rise by the amount of the tax, but consistent with my prior estimates (which I believe Morphh agreed with), producer prices may fall by a max of 10% and, after adding the 39% sales tax, a 25% rise in prices can be expected. (1.00 x .9 x 1.389 = 1.25). Not as bad as a one time 39% rise, but certainly a major disruption in our economy. (3) I haven’t redone my purchasing power and effective tax rate estimates, but I wonder what happens with a 25% retail price increase?
For those of you who want to “discredit” the Rice report, here are a few issues I have with their assumptions. (1) As discussed by others above, the Rice assumption that the EITC and Child Care credits will remain in place, (which raises the revenue required by $48.9B), seems very unlikely to me. Why keep that part of the income tax code and scrap all the rest? Doesn’t the prebate serve essentially the same purpose? (2) It is my understanding that the inventory tax credit was revised from two years to one in the later versions of HR25? The Rice study does address the inventory credit, but spread it over two years. In addition, while both Gale and Kotlikoff ignored the impact of the inventory credit, there seems to be a major disconnect between Rice and the Boortz “Answering the Critics” book? Rice quotes Kotlikoff as assuming the inventory credit would be $184 billion. Boortz wrote it would be $600 billion? Both can’t be right? But if you want to account for the lower estimate, the inclusive rate would be over 30% and the exclusive rate well over 40%. How high is too high? (3) a minor point, but Rice used a .25% of revenue as the administrative cost. I believe it ought to be .5% to account for the state collection activity as well as the business collection costs.
On balance, Rice did an excellent job, and cleared up a number of issues raised by the differing Gale and Kotlikoff assumptions. And, they wrote that everyone is in agreement that taxing the federal government, (or not), should not change the rate. I certainly agree with that, even though I don’t know how Rice handled it in their static study?
Hank — Good summary. My comments:
1. If both Kotlikoff and the Rice folks assume that prices will rise by the full tax-exlusive rate, why would you knock 14 percentage points off that rate? Wouldn’t it be more correct to say that the Rice study assumes that the retail prices of taxable goods and services witll rise by 39%, though some analysts believe the retail price increase will be less.
2. I agree with you on the EITC and the Child Credit. Why would they leave that in? The Prebate is supposed to deal with those types of issues.
3. I agree that the inventory tax credit should be taken into account. I, too, am now confused as to whether it is $600 billion or $184 billion.
4. Doesn’t the 39% exclusive tax rate assume no tax evasion/avoidance? If so, I think that is a key point that would need to brought up in any discussion as to whether this rate is realistic.
5. Did anyone ever figure out what the deficit was in 2006? (The Rice study assumes the deficit would remain the same under the FairTax; I’m curious as to how high it was that year.)
I believe the BHI/Kotlikoff study assumed no accommodation. In any of the studies, the accommodation doesn’t effect the rate - it seems to effect transition costs though which impacted their housing results. While the Rice folks mentioned it, they did not seem to account for real value reduction of government debt when using a full accommodation model. I agree also with you both on the EITC and Child Credit. What they state regarding evasion is “as stressed by Gale (2005), any increased evasion under a national retail sales tax—beyond that already captured by transactions that are omitted in the NIPA (Kotlikoff et al. (2006)—would also reduce the base and increase the required tax rate.”
Hayden,
I guess I spent so much effort trying to come up with a realistic-most likely- price increase that I couldn’t resist using the same logic that produced my 17% price increase on the Rice rate. Don’t want to give the impression that I somehow now support the Fairtax, but I really do think that partial accommodation is the most likely scenario. 20 million greedy producers could prove me wrong by keeping all the loot, but competition counts for something, doesn’t it?
I don’t believe that the Rice study mentioned avoidance, they just commented on evasion as Morphh noted above. Personally, I think avoidance could be a larger problem than evasion, but the only data I can find is a discussion about the “chained” approach to determining the annual COLA for government pensions, etc. Turns out that buying habits can change by more than 20% when prices rise. What on earth will happen when folks are faced with a potential 25/39% price increase for all new goods and all services??? A return to a barter society???
Hank, as you know, if people are faced with a price increase, they’ll also have a wage increase. Sometimes it’s easier to think in terms of no accommodation, but in either case the purchasing power should stay about the same. It’s mainly transition effects that change under different accommodation (full accommodation would put a burden on the owners of existing assets, which would contribute to progressivity in the short run). It is likely that people would save more under the FairTax, which may be a good thing. I think the FairTax covers “bartering”. haha