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August 21, 2009 An Irresistible Opportunity for Successful U.S. Fiscal Stimulus
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While everyone knows that the American consumer has been the weak link in
this recovery, in one sector the fiscal stimulus has opened consumer wallets.
The cash-for-clunkers vehicle trade-in program has been wildly successful, so
much so that it exhausted the initial $1 billion funding limit less than a week
after the program began, leading Congress to add another $2 billion to keep it
going. Now that, too, has run out, so the program will officially end on
Monday, August 24th at 8 pm. Not only have car sales surged,
depleting new car inventories, but automakers in response are increasing
production and employment. Some laid-off workers have been called back and
overtime payments have risen sharply. The Canadian auto sector, and therefore
the Canadian economy, have benefited significantly.
Some of the success of this program is attributable to the ease with which
many of these buyers are getting financing. Rather than hanging onto a clunker
because owners couldn’t afford anything better, Mike Jackson, the CEO of
AutoNation—the U.S.’s largest automotive retailer—says that
most of these owners have very good credit scores. Additionally, there has been
a knock-on effect. All the talk about getting rid of gas guzzlers seems to be
encouraging other potential buyers to visit their local auto showrooms.
The plan offers buyers discounts of as much as $4,500 to trade in older cars
and trucks for new, more fuel-efficient vehicles. Under the initiative,
participating retailers cover the discount and are to be paid back by the U.S.
government. Auto dealers, however, are complaining about slow government
reimbursement. The Transportation Department says it has processed only about
40% of the dealer applications it has received, encouraging a pick up in
government hiring of processors to speed up the payback to cash-crunched
dealers. GM said it will advance cash to dealers to cover the government rebate
until it arrives.
But progress has been slower for another fiscal program intended to
stimulate consumer durables consumption. The first-time homebuyers tax
credit was introduced to help on-the-fence buyers take the home-purchase
plunge. It got off to a lukewarm start, however, because buyers couldn’t
collect the $8,000 credit until tax time, rather than at closing time when the
money is needed.
The program allowed first-time buyers to claim a refundable credit worth
$8,000 (or 10% of the home’s value, whichever is lower). To qualify for
the credit, the purchase must be made before December 1st of this
year. To be considered a “first time” buyer, the purchaser may not
have owned a home during the past three years. They must also live in the house
for at least three years, or they will be obligated to pay back the credit.
Additionally, there are income restrictions: to qualify, buyers must make less
than $75,000 for singles or $150,000 for couples.
After a disappointing early response, the program was sweetened in May to
allow first-time homebuyers to get an advance on the $8,000 tax credit and
apply it toward their down payments or closing costs.
It is clear we are seeing a boost from the homebuyer tax credit. New and
existing home sales have been rising over the past few months, the inventory of
unsold homes relative to sales is finally falling, and house price declines
have slowed. In addition, these first-time buyer sales have a domino effect,
allowing sellers to trade up or down, either way boosting the overall housing
market.
But if the program does terminate as planned on December 1st,
potential buyers are already running out of time. Lenders are reportedly taking
at least 60 days to close (even with a great credit record and nothing going
wrong), which means that for qualifying buyers who haven’t started
searching for a home, the window of opportunity is closing fast. That is what
home builders, real estate agents, mortgage lenders and everyone else who is
trying to stay afloat this year are worried about. If all this cash being
thrown at the housing market is only helping the market find a
bottom, what’s going to happen when the program expires?
Senator Johnny Isakson (R-Ga.), who used to be in the real estate business,
has commanded a lot of media attention as he continues to introduce
legislation1 to increase the maximum amount of the tax credit from
$8,000 to $15,000, expand the credit to apply to any buyers regardless of
income or first-time status, and to extend the tax credit for one year from the
date of enactment. His proposal would still allow homebuyers to claim the
credit on their 2009 tax return for purchases made in 2010.
Senator Isakson has picked up a bipartisan group of co-sponsors for his
proposed legislation. The National Association of Realtors, the
Housing Working Group of the Business Roundtable (a group of CEOs
of large U.S. Corporations), and the Mortgage Bankers Association have
endorsed Sen. Isakson’s bill.
Enhanced direct demand-side support for the U.S. housing sector has a good
chance of passage. Homeownership is the great American dream, and the public
has always supported government subsidization of the sector. Support continues
despite the effect that such subsidization has had in triggering the subprime
mania and ensuing housing collapse. Supporters argue that these measures will
jumpstart the housing market and stimulate the broader economy.
With its strong Republican backing, there is nary a word about the cost of
the program and its impact on the budget deficit. The Joint Committee on
Taxation provided a revenue estimate for Isakson’s bill assuming an
enactment date of July 1, 2009 (which, of course, will not be the case). The
committee estimates that the proposal would reduce cumulative federal budget
receipts for fiscal years 2009-2014 by about $38.5 billion.2
Arguably, the impact on the federal deficit would be smaller to the extent the
tax credit boosts economic activity sufficiently to reduce the economically
sensitive components of government spending such as welfare payments or
unemployment insurance.
Bottom Line: The cash-for-clunkers program has been so successful
that we can expect to see expanded positive incentives for targeted consumer
spending. The opportunity to extend the expiring first-time homebuyer tax
credit would be a huge political win for the Republicans and hardly a Democrat
will stand in its way.
An expanded and enlarged homebuyer tax credit could well trigger an
unexpectedly large boost to housing demand at a time when mortgage rates are
still low and pent-up demand is high. It would not only boost first-time buyer
demand, but would also jumpstart the move-up and retirement home markets as
well. Housing is the most interest-sensitive sector of the economy and it has
long been the traditional transmission mechanism for monetary policy. It could
well be an important transmission mechanism for fiscal stimulus through a
broadened and extended homebuyers’ tax credit.
Home buying also leads to housing-related expenditures like furniture and
appliance purchases, painting and other upgrades, and energy-efficiency
spending. The positive impact on the overall U.S. economy could be large and of
course U.S. trading partners would benefit. Canada could stand to benefit the
most as U.S. demand for lumber, copper and other building materials, as well as
the multiplier effects on U.S. demand for all Canadian exports, could be
substantial.
- This proposed legislation was first introduced by Senator Isakson in
January 2008. He has subsequently re-introduced the amendment repeatedly,
attempting to attach it to the fiscal stimulus legislation passed in February
2009 and most recently on August 6th to the legislation that
expanded the cash-for-clunkers program.
- A tax credit is considered a reduction in tax revenues.
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