Getting tax policy backwards

In the WSJ, Jeff Yass & Steve Moore play the world’s smallest violin for the poor homeowners who are sitting on more than half a million dollars of nominal capital gains and therefore cannot sell. If only that tiny number of millionaires faced lower taxation, they reason, more homes would come on the market and prices would fall. This is ridiculously silly and reverses the correct economic logic. First, let’s think about the current set of incentives. Currently, a homeowner can sell and write off $500k of home value increase before paying any cap gains tax. Granted, that’s a kludgy policy. A $500k gain over 10 years is quite a bit different than the same gain over 40 years! But the current kludge has precisely the opposite effect that Yass & Moore hypothesize. It incentivizes frequent moves. Imagine two rich homeowners who each gain $2 million in nominal value over the course of 40 years. One stays in her first home. The other moves every decade. The mover pays far less in cap gains taxes than the stayer. That is, we have a kludgy tax provision highly attuned to incentivizing regular moves among the wealthiest & luckiest homeowners. Yass and Moore’s proposal would do the opposite of what they say it would do.

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Yass and Moore’s second mistake is that they forget what people do when they sell a house: they go out and buy another one. If the people in question are downsizing or moving to a nursing home, then the cap gains tax isn’t a liquidity barrier, just a wealth effect. If they need the full value of their very-expensive home to buy their next home, then they’re adding just as much to the demand side as to the supply side. Once again, Yass & Moore have it backwards: taxing affluent movers puts a wedge in between their contributions to supply and demand. (That’s not proof that it’s a good thing, just an honest accounting for its effects.)

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Housing tax policy is under-discussed in YIMBY and pro-affordability circles. The 1982-1987 period was one where highly favorable tax treatment led to a major condo-building boom. A much better policy for affordability than the one that Yass & Moore propose would be to decrease taxes on new construction (there are several ways) and offsetting that with a tax increase on existing homes. This is classic capital taxation policy: to optimize growth, you want to minimize taxes on new capital. What’s a fair way to increase taxes on existing homes? Many have suggested eliminating the mortgage interest deduction. But that would create weird incentives vis-a-vis other investments. (In general, interest paid is deductible). Rather, housing cap gains could be better aligned with other cap gains. Yass & Moore are 1/4 right after all: cap gains on housing could indeed be indexed to inflation going forward, but only if paired with removing the $500,000 exclusion.

I welcome more research and creative thinking on housing tax policy. But it has to begin with an honest account of the existing policy baseline.