Can first-time buyer tax incentives solve American's housing crisis? Let's cut to the chase.
No.
A tax credit cannot cure the problems being experienced in the US housing market. A tax credit provided to buyers alters the financial calculation on the demand side of the equation. The affordability problem being targeted is actually due to the supply of housing. This is much easier to see by creating a relatively simple graph of some of the key variables driving supply and demand.
Visualizing the Problem
The housing problem in the US stems from the simplest factors in any economic analysis -- supply and demand. The supply of housing is not keeping up with the demand by new households. When supply Is behind demand, basic economic theory indicates prices go up. But what is the magnitude of this imbalance? Plotting population growth and housing starts over a period of time is an intuitive way to show the relationship between the two.
If supply was responding adequately to changes in population, a graph of housing starts should have a positive 1:1 correlation with population. But does it? In the real world, the correlation won't be perfect because actual housing purchases are influenced by business cycle issues. However, one would still expect the overall correlation to be fairly direct over a longer period of time. But is it?
Using federal government statistics on population and housing starts from 1990 to 2023, the following graph was produced to reflect the variation in housing starts over that period.
The purple line shows how US population has grown from 248 million in 1990 to 341 million in 2023 against the right y-axis scale.
The black line reflects actual yearly housing starts in 1,000s units.
The gray line depicts a smoothed estimate of housing starts required to keep up with actual population. This "average" was generated by first averaging the ratio of starts/population from 1990 to 1999, a period that began in recession and ended with the first Internet bubble but in general reflected some of the cyclical nature of the housing market in a 1990s context. That average value for starts/population was then applied to the actual population figure for each year from 1990 through 2023 to graph that line.
The yellow line is each year's shortfall between the "smoothed" starts number that "should" have been built based on historical averages and actual starts.
The red line is the running accumulation of all prior year shortfalls (excess) of actual starts compared to the smoothed benchmark. Because it is labeled a "shortfall", it graphs as a negative number when there is an actual excess.
So what are the key points conveyed by this graph?
- While US population is still growing, the RATE of growth is slowing steadily year after year.
- Housing starts peaked in 2005 at 2,068,000. While everyone thinks of the financial collapse occurring in 2008, this reflects that actual housing starts began falling precipitously in 2006 and that drop actually triggered recognition that mortgage markets would collapse.
- Beginning in 2007, actual housing starts fell BELOW the smoothed gray trend line and have never surpassed it since. If you accept the intent of that gray smoothed line, this means actual new housing starts have never caught up to erase the prior deficits.
- The red line shows that all of the housing inventory of homes started during the housing bubble between 2002 and 2009 was absorbed by demand and since 2009, the deficit of new housing units has grown every year.
The real takeaway from the graph is that based on the assumptions explained above, the actual magnitude of the housing gap in the US right now is 7,759,000 units. That can trigger thoughts in a few different directions. First, in the entire series of data, the biggest "overage" between actual starts and "needed" starts was about 500,000 units in 2005 that occurred at the peak of the housing bubble. If 500,000 is some sort of upper bound on the ability to create housing in excess of normal market demand, that means eliminating that cumulative gap of 7,759,000 units would take nearly sixteen years to catch up.
Second, a legislative plan that aims at providing a $25,000 in down-payment assistance and a $10,000 tax credit for first-time homebuyers may stimulate demand for HOUSING but may do NOTHING to provide incentives for builders to build NEW housing in lower price ranges. Think about it. The benefit is provided to a person who buys a home for the first time. The requirement is NOT constrained to the home being new which means the incentive doesn't drive behavior regarding actual construction that addresses the net shortage. Such incentives could simply encourage a shuffle between renters and owners, drive up prices in the short term and leave the total supply of housing unchanged.
Thirdly, and possibly most importantly, any incentive targeting first-time buyers is altering incentives for buyers who are already on the fringe of affordability. That fringe cuts both ways. They might think they only need one or two more years of scrimping and saving to afford a home and now a tax credit would bypass that wait. They might also NOT be one or two years away. The credit might tempt them into buying something they still cannot afford through an unexpected repair, a temporary loss of income, etc. and they may wind up in a cash flow situation that forces them to sell to escape the financial commmitment. They could take a significant percentage loss on the house and pay a significant commission to an agent to assist with unloading the house. Buying a house at this economic stage of life is one of the riskiest decisions one can make.
This graph still doesn't convey all of the complexities of the housing market and all of the forces at work in placing homes out of reach of average citizens. Consider these factors:
Household Size -- Technically, housing demand isn't driven directly by population. It's driven by the number of "households" which is a function of total population divided by average household size. Household size is a function of individual decisions to marry or cohabitate and to have children. For a given fixed total population, halving average household size from 4 to 2 would logically double demand for housing units. The graph above shows that overall population growth is slowing which would imply needing lower growth in housing units with all other factors held constant. But at the same time birth rates are falling, the share of adults living alone has been growing, which increases demand for housing, possibly negating the impact of slower total population growth.
Household Income -- Splitting up the cost of a mortgage across two incomes is a common benefit sought by anyone who marries or cohabitates. Obviously, if fewer adults are getting married or cohabitating and instead are choosing to live alone, they are presumably facing a mortgage payment alone as well, on a single income. By definition, that will remove a large swath of buyers from the market.
Construction Labor -- The plot of population in the graph above has implications for the market for construction labor required to build new housing. In the US, yearly births peaked in 2007 at 4.32 million and are around 3.67 million as of 2022. The "Alpha" generation born between 2013 and 2027, that bloc of workers is estimated to be about 56.48 million. When they begin reaching working age in 2031, that generation will be 13.1 million smaller than the generation preceding it, which was already smaller than its predecessor. And trades are not attracting new workers. (Edtiorial anecdote: A family member recently remodeled a 1971 home and the firm that did the work was a brother duo who were both nearing 70 years old.) Twenty-somethings may be unhappy with the prospect of sitting behind a keyboard on Zoom meetings all day but relatively few are volunteering to learn how to frame a house or install and repair plumbing.
Zoning Constraints -- Local zoning restrictions are based on assumptions and prejudices (social and technical) dating from the 1950s. From 2024 looking back, this collection of zoning patterns could be termed America's second original sin -- the decision to subsidize standalone home construction via highway construction, tax deductions for mortgage interest, building height limits, street setback rules and restrictions on MDUs (multi-dwelling units). As dozens of YouTube content creators have documented, the result is a world in which modern, efficient housing solutions that could meet demand for single-tenant units and offer walkable streets and mass-transit friendly access to office centers for work are actually ILLEGAL in the vast majority of the US. This environment reflects a complete failure of imagination on the part of politicians, planners and the public. Americans cannot fathom the concept of not owning a car, of taking a ten minute bus ride to work, of having a corner bar three blocks away they can walk to. Call it Synchronicity Syndrome.
Another working day has ended
Only the rush hour hell to face
Packed like lemmings into
Shiny metal boxes
Contestants in a suicidal race
Bigger Homes and Bigger Margins -- If you are a contracting firm facing these market conditions of limited supply of locations zoned for building, limited labor supply and rising prices, what is the best way to maximize your profit? Building a larger home for the few who can actually afford a home. What does that do to new home prices? Increases them. What does it do to "comparable" valuations for nearby existing homes? Increases them as well. What does it do to average prices overall? Pulls them up? What happens to entry-level customers? They get priced out of not just the new home market but more existing homes as well. This dynamic should be very familiar to Americans. This is exactly what happened with vehicle prices during the pandemic, especially large trucks and battery powered vehicles.
What COULD Work?
The overall thesis here has been that attempts to manipulate demand for housing will do little to solve the core problem of supply. Solutions must focus on the supply side of the equation; the supply of available lots, the density of construction allowed on those lots and the supply of labor required for construction. Here are a few policies likely to have a direct impact on supply.
Tax Credits for MDU Complexes Between 4-16 Units -- To encourage higher density without triggering fears among existing citizens of the next Cabrini-Green or Pruitt-Igoe disaster, federal subsidies could be provided to cities for completed construction of new MDU complexes (apartments or condominiums) sized between 4 and 16 units. Why that range? The lower value ensures a significant increase in average density over 1.0 needed to make headway while utilizing space more efficiently. The upper limit ensures developers don't build one, large, cheap hell-hole tower to claim the credit and build an unlivable space that antagonizes local citizens. Paying the subsidy to the city ensures the city alters codes and actually permits the construction to produce actual new units.
Tax Credits for Office Rehabilitation -- Work-from-home trends have easily reduced demand for office space by 20 to 30 percent nationwide. Much of that empty space is "trapped" because buildings are seldom emptied completely. A firm may still retain 100% of its lease but only have 60% of workers present on any given day or some tenants may leave with others staying. Office space constructed in the last twenty to forty years was heavily optimized for office use and often lacks elements that would simplify re-purposing the space as individual housing units. If WFH continues indefinitely, this stranded space represents hundreds of billions of dollars in trapped real-estate that will crater in value and cripple municipal tax revenues unless a solution can be found. Offering tax incentives for firms that can devise economically sound ways to re-purpose these buildings is very much in the nation's interest.
Tuition / Training Reimbursement for Trades -- The US is already operating with 4 percent unemployment. Any able-bodied person with trade skills interested in working is already employed and unable to take on more work. Individuals wanting to get trade work completed for a new home or remodeling project routinely see three to six-month delays in scheduling. Actual construction intervals are now seven to twelve months. Twenty to thirty years ago, construction might have taken six months from contract to close. Slips in schedules due to labor shortages for a sub-contractor have exponential impacts on the overall schedule so any programs that increase the supply of trade workers can reduce construction times and increase units delivered.
Immigration Reform -- The US already offers special work visas for in-demand high tech workers. If businesses, communities, educators and politicians are unable to devise incentives to encourage young people to enter and stay in the trades, the most immediate alternative to increase the labor supply is to further leverage immigration. I say "further leverage" because America is already highly dependent on this labor pool. Even in the landlocked Midwest, I have not seen a roofing crew or a fiber optic cable construction crew that wasn't heavily dominated with immigrant workers.
Innovation in Construction Techniques and Materials -- In a world where homeowners and general contractors use CAD tools to design decks and kitchen remodeling projects, it seems odd that "stick frame" construction is still used in most US new homes, especially when most new homes are NOT custom designs but instead picked from a set of maybe eight available plans per builder who may build twenty nearly identical homes in the same subdivision. An easy way to improve quality, improve efficiency of materials usage and reduce labor content involves modularizing construction. Builders already do this for roof trusses, why not walls? If Americans don't want to work outdoors AND think trade work is beneath them AND oppose immigration to let someone else do the labor, the only alternative left is to eliminate more of the labor. Should the federal government create tax incentives for firms that manufacture equipment for CAM (Computer Aided Manufacturing) of modular homes or use CAM to build modules for retail builders? The tools themselves already exist. The problem is more related to providing enough incentives to get builders to adopt the methodology in their designs.
WTH