The latest data show that the US housing market may finally be starting to thaw, yet there's a simple reform that could be a lasting answer to America's long-running issue of housing supply.
Moody's economist Mark Zandi has issued a lot of stern warnings about the state of the US economy lately, and now he's turning his attention to housing. In a paper published with fellow economist Cristian deRitis this month, he laid out why the capital gains tax on home sales is keeping throttling the supply of homes for sale, exacerbating the supply-demand imbalance that's been growing for years.
Zandi and deRitis' analysis centers on the market mismatch that the capital gains tax has caused, forcing older Americans to remain in their homes despite their desire to downsize.
"For long-tenured homeowners, capital gains taxation creates transaction costs that can easily exceed $100,000 on modest properties in high-appreciation markets," they said.
Many homeowners are sitting on massive paper gains after years of stellar home-price appreciation. However, the tax bill on a sale today is much higher than when some people bought their homes, leading to owners opting to stay put. This is among the factors that have led to a logjam in the housing market, keeping prices high and supply low.
The authors highlighted the Taxpayer Relief Act of 1997, which said owners could exclude capital gains of $250,000 for single filers and $500,000 for married people filing jointly.
The policy was intended to help sellers who had occupied their home for several years avoid paying heavy taxes upon selling it. However, as Zandi and deRitis noted, it hasn't been updated in decades while home prices have surged.
"If the caps were indexed to house price growth, they would now be $885,000/$1,775,000. If indexed to consumer price inflation, they would be $500,000/$1,000,000," the economists estimated.
As Business Insider has reported, the policy has compelled many Americans to avoid selling their home.
In Zandi and diRitis's view, reforming these caps could strengthen the economy by boosting mobility for current owners.
"Various reform approaches range from modest indexing to inflation, which would reduce collected revenue by $3 billion to $5 billion annually, to total elimination, which would lower revenue by $6 billion to $10 billion on a static basis," the paper said.
The authors added that, given the magnitude of the current housing market distortions and their negative impact on economic growth, fully eliminating the tax would mean only a modest increase in federal spending, one that would be easily offset by the economic benefit provided by reforming the caps.
"Over time, the housing market would readjust as middle-income buyers move up and out of their starter homes, potentially freeing up inventory at the lower end of the market," the economists wrote.
"In addition, some older buyers could be expected to occupy the excess supply of new townhouses and condominiums built in recent years. Filling these units could lessen price pressure on existing homes."
