1. A maximum exclusion on the gain from a sale of a home of $250,000 ($500,000 for married couples).
2. Tax-deductibility of mortgage interest (unlike interest on other forms of consumer debt).
These tax preferences make real estate more attractive than other capital assets. They also provide an incentive for taking on greater leverage in making real estate purchases. Excessive leverage is a key reason the fall in home prices has substantially undermined the nation's banking system.
Canada, by the way, does not permit the tax-deductibility of mortgage interest and allows a deduction of two-thirds of the gain on a sale of a home ensuring that every home sold at a gain results in a tax on that gain. Yet, more than two-thirds of Canadians own their own homes (a rate that will, ironically, wind up higher than the U.S. rate by the time the current recession ends).
Of course, I highly doubt that the role the popular tax preferences allowed for real estate would gain the scrutiny they deserve except in economics journals and among academics. Yet, it is plausible that those preferences played a significant role in helping feed the real estate bubble once the mania was underway.
Finally, I highly doubt that were the Fed to make home price stability a component of its monetary policy goals that such an approach would be embraced. Nevertheless, emerging findings by economists suggest that the risks associated with real estate bubbles merit possible monetary policy consideration. Indeed, in its February 6, 2009 report on the initial lessons of the ongoing economic crisis, the IMF recommended, "Central banks should adopt a broader macro-prudential view, taking into account in their decisions asset price movements, credit booms, leverage, and the build up of systemic risk." It added, "The timing and nature of preemptive polic responses to large imbalances...needs to be reexamined." In other words, the Fed's existing "hands off" approach when it comes to preemptively curbing real estate price appreciation is something that the IMF believes needs to be reexamined.
The bottom line is that the housing bubble and its after effects were the consequence of a large number of factors. Federal policy that aimed at expanding home ownership to lower-income persons via expansion of the Community Reinvestment Act (CRA) and role played by Fannie Mae and Freddie Mac are just one aspect of the matter. Longstanding and highly popular tax preferences are another. The lack of a monetary policy tool/response to rising home prices is another. The role innovation (particularly securitization and the rise of synthetic finance) played is another. One cannot reduce the risk and mitigate the consequences of future housing bubbles without taking a comprehensive look at all of the factors that contributed.
Now, to be sure, I am not necessarily arguing for repeal of the real estate-based tax preferences, and even if repeal were the approach, a grandfathering for existing homeowners or incremental phaseout for a transition would be necessary. I am suggesting that a pragmatic and comprehensive examination is in order and one cannot create "sacred cows" that are exempt from scrutiny. The problem was far more than the result of "social engineering."
Indeed, during the 1980s Japan saw the rise of a massive housing bubble that had nothing to do with policies remotely similar to the CRA or institutions modeled after Fannie Mae and Freddie Mac. The international experience contains a large number of cases of destructive housing bubbles. There is far more to the story than "social engineering." Furthermore, when such bubbles collapsed the economic contractions were, on average, far more severe and longer-lasting than recessions associated strictly with the business cycle.