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An Examination of the First-time Homebuyer Tax Credit - first time home owner tax credit


An Examination of the First-time Homebuyer Tax Credit-first time home owner tax credit

An Examination of the First-time Homebuyer Tax Credit
Erik Hembre
June 18, 2018
Abstract
A major policy response to the 2008 housing crisis was the First-time Homebuyer Tax Credit,
worth up to $8,000. To estimate the tax credit effects on homeownership, I construct a quarterly
first-time homebuyer time-series using American Housing Survey data and utilize a difference-in-
difference framework using variation across income levels among first-time homebuyers. I estimate
the tax credit induced 399,846 first-time homebuyers and calculate an economic cost of $27,010
per induced homeowner. Estimating state- and MSA- level effects using variation across homebuyer
status, I find a strong correlation between local effect size and average home values, with a doubling
in average home values implying a drop in effect size by 18.8 percentage points.
JEL Classification Codes: R21, H5, I38
Keywords: Homeownership, Policy, Public Assistance
Erik Hembre: University of Illinois at Chicago, ehembre@uic.edu.
1 Introduction
One of the largest policy responses to the 2008 housing bust was the First-time Homebuyer Tax Credit
(FHTC). In an attempt to boost housing demand, this novel program offered up to $8,000 to first-time
homebuyers between April 2008 and September 2010. Over three million households claimed the
credit at a monetary cost of $21.1 billion, but how many of these households bought homes because
of the FHTC? Figure 1 displays annual first-time homebuyer shares. These shares have been relatively
smooth over the past fifteen years at around forty percent except for a jump to fifty percent during the
FHTC eligibility period. This indicates that a sizeable FHTC response occurred and warrants further
investigation. This paper measures the FHTC effects by estimating the number of households induced
into homeownership at both the national and local levels, and then analyzes these results to determine
where and why the policy was most effective.
A federal tax credit targeting first-time homebuyers had never been offered prior to 2008.1 In
theory, a tax credit targeting first-time homebuyers could be a useful tool for policymakers during a
housing bust. If house prices drop and induce a rash of foreclosures, these newly vacant homes create a
shock to housing supply, driving house prices down further. To bring house prices back towards equi-
librium, these vacant homes either need to be filled with new homeowners, turned into rental properties,
or else demolished. Offering a tax-credit to first-time buyers helps induce more renters into homeown-
ership, filling these vacant homes. A homeownership tax credit can additionally boost general housing
demand on the intensive margin by prompting first-time buyers to purchase larger homes.
Aside from a housing bust policy tool, a first-time homebuyer tax credit may provide social bene-
fits due to the positive externalities of homeownership. There has been much debate among economists
as to the existence and magnitude of homeownership positive externalities. Evidence of these external-
ities often center around either improved exterior home maintenance, improved outcomes for children,
or increased participation in local organizations.2 While quantifying the financial value of the home-
ownership externality has remained difficult, recent work by Coulson and Li (2013) suggests that an
additional homeowner creates $1,300 in annual externality benefits.
Several policies are already in place to subsidize homeownership, including the mortgage-interest
deduction, deduction of state and local property taxes, housing capital gains exclusion, and mortgage
revenue bonds. According to Keightley (2014), these subsidies cost the United States $147 billion in
2017, with $83 billion from the mortgage interest deduction alone. A first-time homebuyer tax credit
has several advantages to these alternative homeownership promotion policies. These advantages stem
from the fact that the FHTC directly targets the outcome of interest, homeownership, as opposed to indi-
rectly through mortgage finance or property taxes. As a result of subsidizing mortgage interest, Hanson
(2012) finds the mortgage-interest deduction does not increase homeownership but instead works on the
intensive margin of housing demand by increases home size between 10.9-18.4%. Similarly, Glaeser
and Shapiro (2003) uses variation across states in the deductibility of mortgage interest and finds only
1I have found just one instance of a first-time homebuyer tax credit at the local level (Tong (2005)) offering $5,000
between 1997 and 2001 in Washington, D.C.
2Examples includeDiPasquale and Glaeser (1999), Green and White (1997), Rossi-Hansberg et al. (2010), Coulson et
al. (2003) and Harding et al. (2000).
1
a small positive relationship to homeownership. By using income tax deductions, the mortgage interest
and property tax deductions only benefit households that itemize their tax returns, meaning benefits are
mostly realized by higher income households. This regressivity works directly against the motivation
for a progressive tax code. Research by Green and Vandell (1999) models the housing tenure choice
of households while incorporating tax incentives. Green and Vandell (1999) finds that replacing the
mortgage-interest deduction with a similarly sized homeownership tax credit would boost homeowner-
ship rates by 3 to 5%. While Green and Vandell (1999) consider an annual homeownership tax credit as
opposed to a first-time homebuyer tax credit, the mechanisms for boosting homeownership are similar.
By using a fixed-price subsidy and linking the tax credit directly to homeownership as opposed to indi-
rectly through mortgage financing, a homeownership tax credit provides a more efficient alternative to
the mortgage interest deduction.
Against these benefits, policymakers must weigh the expected costs of a homeownership tax
credit. As a group, homeowners are wealthier than renters are. This means that the tax credit works
against the redistributive goals of progressive taxation. Even if bulk of the FHTC cost is simply a wealth
transfer towards homeowners, the FHTC benefits must be weighed against the cost of raising the funds
to pay for it. Since the FHTC subsidizes homeownership, it distorts the housing tenure decisions con-
tributing to the economic costs of the program. Further, renters on the margin of homeownership may
be higher credit risks and more likely to default on their mortgage. This would increase foreclosures,
which are costly to homeowners and the general public.
The effectiveness of the FHTC depends on the elasticity of homeownership, or analogously the
"price" of homeowners. By price of homeowners I am referring to cost per induced homeowner. The
more elastic renter demand is for homeownership, the cheaper it will be to buy homeowners and fill va-
cant homes. Ex ante, predicting the response of first-time homebuyers to the FHTC is difficult because
it is a new program with few prior studies to draw from. Research into the effects of the mortgage-
interest deduction on housing tenure choice often finds minimal if not zero effects on homeownership.
Hilber and Turner (2014) considers state variation in mortgage interest deduction combined with hous-
ing supply elasticity and finds only small homeownership effects concentrated among high-income
individuals living in less-regulated housing markets, implying a cost of $28,397 per new homeowner
per year.
A difficultly of measuring the homeownership elasticity is quantifying the relative size of a home-
ownership subsidy. Since $8,000 is only about three percent of the average home purchase the FHTC
could be seen as a trivial subsidy. However, this tax credit incentivizes homeownership consumption
but not necessarily housing consumption. Housing consumption is better represented by the "user
cost" of housing, which includes the cost of raising the down payment amount, mortgage financing
costs, and the transaction costs of moving and selling the home. While the user cost is clearly hetero-
geneous across households depending on creditworthiness and expected tenure, a useful approximation
is to use five percent of the home value annually (Himmelberg et al. (2005)). If an average first-time
homebuyer lives in their home for five years, the FHTC would then subsidize ten percent of the user
cost (assuming a six percent realtor transaction fee as well). This subsidy rate changes with the size of
home purchased. Purchasing a $100,000 home would imply a subsidy rate of twenty-five percent while
purchasing a $500,000 home would only subsidize five percent of the user cost of homeownership.
2

Can you still get a first time home buyer tax credit?Reps. Earl Blumenauer and Jimmy Panetta introduced the First-Time Homebuyer Act in the House in late April. The bill, which closely resembles what Biden proposed during his campaign, would create a refundable tax credit worth up to 10 percent of the purchase price, or $15,000, for the purchase of a home.

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