Latest Homebuyer Tax Credit: Pay More, Get Less

Posted by: Prashant Gopal on November 04

Congress is getting ready to pass a new, expanded $10.8 billion tax credit for homebuyers. President Obama’s could have it on his desk by next week.

But a new report from Goldman Sachs suggests that the six-month extension might do little for the fragile housing market and could be even less effective than the soon-to-expire credit for first-time buyers that cost taxpayers about $8.5 billion and lasted nearly a year.

The Congressional proposal would give buyers until April 30, 2010 to sign purchase contracts and another 60 days to close. And it will no longer be just for first-time buyers. Homeowners who have lived in their current home for five of the last eight years can claim $6,500, under the new law, which would only apply to houses purchased after the current tax credit expires Nov. 30. Income limits will be more generous: $125,000 a year for individuals, $225,000 a year for married couples.

But Goldman Sachs economist Alec Phillips says, in a report released to clients Nov. 3, that the expanded program won’t raise home prices and sales much and likely won’t significantly trim the supply of unsold homes.

“The extension of the current credit will probably result in some incremental first-time buying but not as much as the last one,” Phillips said in a phone interview today. “The expansion to the other population of buyers [existing homeowners] will provide a small boost to prices, but no more than 1%.”

According to Phillips’ calculations, all but about 200,000 of the 1.4 million first-time buyers who claimed the credit this year would have purchased a home even without the incentive. And the credit resulted in boosting home prices only by about 1%(Phillips assumed in his calculation that home prices rose in part because sellers built a large portion of the credit into their asking prices).

The pool of first-time buyers who still need an incentive to get off the fence is likely small because many of them have already taken advantage of the now-expiring credit. Existing homeowners who qualify for the new $6,500 credit could spur additional sales. But the supply of unsold homes will remain unchanged because most homeowners will have to sell their existing home in order to buy a new one (The credit only applies to principal residences).

This doesn’t mean that the credit is useless, only that it is inefficient. For one thing, it could stimulate the economy by giving consumers more money to spend. (Economist Simon Johnson argued in the Washington Post last week that the tax credit is both inefficent as a homebuyer incentive and as a economic stimulus).

“We were not arguing that [the expanded credit] would have no effect,” Phillips said. “Just will the effect be as great as last one?”