Crawl Across the Ocean

Tuesday, January 27, 2009

Almost forgot...

...About the dumbest idea in the budget which was the First Time Home Buyers Tax Credit.

If only there was somebody somewhere in the government who understood the first thing about economics they might realized that paying people to buy houses only drives up the price. It doesn't help first time home buyers - it helps existing home buyers.

Let me explain this slooowly. Prices are set by supply and demand. Increasing demand (through tax breaks for purchasing a home) will cause the price to rise. Since prices for houses are already set to whatever the market will bear, this tax break is a subsidy for those who already have a house as it will increase the price they get when they sell it.

If you want to help first time home buyers, stop trying to increase demand and instead increase supply, or, given that we already have too much supply, simply stop trying to increase demand and then stand back and let prices fall to their natural level (i.e. the one people can afford without subsidies from the government).


Update: I should add that if we were talking about some easily manufactured widget, then an increase in demand might just mean making more for the same price to meet the demand. But houses don't work like that, house prices relate more to what people can afford to pay than they do to the cost to build them.

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  • Is the objective of the policy to help first time home buyers in the way you suggest ( lowering prices ) or to help convince people to buy a first home?

    By Blogger KevinG, at 9:19 AM  

  • Yes, that's just one of many potential valid objections to my hastily written post. I have to take it back really, the home renovation tax credit is much dumber than this tax credit is.

    By Blogger Declan, at 7:21 PM  

  • I had to think about this one.

    Assume the stock of houses is large relative to the flow of new houses that will be built as a result of the temporary subsidy to first time buyers (reasonable assumption). So the stock supply is (near) perfectly inelastic.

    There are two types of buyers: first-time buyers, and multi-times buyers (who have previously owned a home, but who do not own one currently). If you gave a $100 subsidy to both groups, the price would rise by (nearly) $100. But if you give a subsidy just to the first group, the price will rise by less than $100. For example, if the two groups are equal in number, and have the same elasticity, the price will rise by (nearly) $50.

    Conclusion: it helps sellers ($50 each); it helps first-time buyers ($50 each); it hurts multi-time buyers ($50 each). "Traders" (those both buying and selling a house) aren't affected, since they gain and lose $50.

    It also helps home builders ($50 each).

    If nearly all buyers were first-time, and very few multi-time, the price would rise by (nearly) $100, and we get your result. Only the sellers (and builders) gain.

    It's a really good micro question.
    I'm trying to decide whether to steal it for Worthwhile Canadian Initiative...

    By Blogger Nick Rowe, at 12:00 AM  

  • Nick, 'steal' away.

    Keep in mind that the market (type of houses) for first time buyers is different from the market for move-up buyers and that the market for first time buyers is, naturally, dominated by first time buyers.

    By Blogger Declan, at 9:38 AM  

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