How to Fix the Housing Bias That Warps Investment Decisions
Overinvestment in real estate is a problem for the economy. A growing body of research suggests that it saps future output by sucking capital away from more productive uses. And housing is a particular culprit.
There are a number of possible ways to solve the problem—none of them easy.
Homeownership bias, meaning the incentive to invest in property rather than other assets, exists in the most of advanced economies. This means less money is invested in things that boost productivity like machinery and new technologies.
When thinking about how housing is taxed, it’s useful to think of ownership and actual use—as in living there—as separate economic categories. Owning a property is the investment side of the equation, but living there is a form of consumption.
If a homeowner rents out their property, that income is taxed. But when they live in it, essentially renting it to themselves, it isn’t. And that is the major advantage to homeownership over other forms of asset ownership: Imputed rents aren’t usually taxed.
Combined with other tax incentives, the effective subsidy can be huge. A 2017 paper estimated that excess consumption of housing services in the euro area—the amount spent on housing, relative to what would likely be the case if it wasn’t encouraged by favorable taxation—is equal to 30% of homeowners’ holdings of financial assets across the entire bloc.
So finding a way to tax imputed rent, even if it means reaching a very conservative estimate of rental values, could reduce the disparity in treatment between asset classes.
There’s another side to the equation. If an investor wants to buy stocks, they can’t easily borrow many times their income at fixed interest rates to do so. Housing is a different story: In the U.S. the mortgage interest deduction reduces tax bills for borrowers, encouraging even more property investment.
There’s some good news on that front. Tax changes in 2017 reduced the total subsidy of that deduction by more than half. It now reaches fewer wealthy homeowners and could be reduced further.
That is all very well for relatively open markets like the U.S. The challenge in China is far greater. Restricted by capital controls from easily investing abroad, Chinese households have very few good options for parking their savings. Opaque wealth-management products or the often casino-like stock market aren’t real alternatives to property for most people. And many believe the government will always act strongly if property prices really start to fall.
Governments need to tread very carefully, since property income forms a large portion of middle-class wealth. In some countries, China in particular, the allocation toward housing is overwhelming.
More adventurous suggestions include a tax on the value of land, to encourage more efficient use and to more reasonably share the uplift in values that owners typically receive through luck alone. But even without such big measures, there are many smaller ways to limit the overinvestment in property currently dragging on productivity.
Write to Mike Bird at Mike.Bird@wsj.com