The First-Time Homebuyer Tax Credit: An Economic Analysis

The First-Time Homebuyer Tax Credit: An Economic Analysis

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epared for Members and Committees of Congress

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
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ž––Š›¢ȱ
The Housing and Economic Recovery Act of 2008 (P.L. 110-289) enacted a temporary tax credit
for first-time homebuyers that was intended to address two housing market concerns: an excess
supply of homes on the market and falling prices of homes. The American Recovery and
Reinvestment Act of 2009 (ARRA; H.R. 1, P.L. 111-5), as agreed to in conference and signed into
law by the President, recently increased the value of the tax credit for home purchases in 2009
and extended the period over which the credit applies. Proponents argue that the tax credit will
help to reduce the supply of homes on the market and stabilize home prices by stimulating home
buying. Opponents argue that the design and administration of the tax credit, coupled with
general economic uncertainty, prevent the tax credit from achieving its intended objective.
As a result of the provisions in ARRA, the amount that a first-time homebuyer in 2009 may claim
as a credit against their federal income tax liability is equal to a maximum of 10% of a home’s
purchase price, or $8,000. The credit is limited to a maximum of $7,500 for buyers in 2008. The
credit amount is reduced for individuals with modified adjusted gross income (AGI) of more than
$75,000 ($150,000 for joint filers), and is zero for those individuals with modified AGI in excess
of $95,000 ($170,000 for joint filers). The tax credit is refundable. Homebuyers that purchased
their homes in 2008 must repay the tax credit. The repayment requirement is waived for home
purchases made in 2009 unless the home is sold within three years of purchase. To qualify for the
credit the buyer must not have owned a principal residence in the last three years. In addition, the
home must have been purchased after April 8, 2008, and before December 1, 2009.
This report analyzes the ability of the first-time homebuyer tax credit to stimulate home buying
and stabilize home prices. Because the tax credit may not be claimed until after a home purchase,
it is unlikely that the tax credit will be of great help to a large number of potential homebuyers
that need down payment and closing cost assistance. In addition, the requirement that some
homebuyers must repay the tax credit greatly reduces the credit’s effective value for those buyers.
Lastly, as long as forecasts predict that home prices are falling and that the economy will remain
weak, a large fraction of potential homebuyers may choose to remain on the sidelines with or
without the tax credit.
This report concludes with a review of policy options available to Congress. These options
include modifying the tax credit’s value, modifying the tax credit eligibility criteria, and allowing
for the tax credit to be advanced.
This report will be updated as warranted by legislative events.

˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
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˜—?Ž—?œȱ
Introduction ..................................................................................................................................... 1
Current Economic Conditions ......................................................................................................... 1
The Housing Market ................................................................................................................. 1
The Broader Economy .............................................................................................................. 2
The First-Time Homebuyer Tax Credit ........................................................................................... 3
Economic Analysis of the Tax Credit .............................................................................................. 4
Marginal First-Time Homebuyers ................................................................................................... 4
The Cost of Homeownership........................................................................................................... 5
Tax Credit Induced Price Reduction ......................................................................................... 5
Annual Cost of Homeownership ............................................................................................... 6
Buyer Response to the Tax Credit............................................................................................. 8
The Influence of the Economy and Future Home Prices................................................................. 9
The D.C. Homebuyer Tax Credit..................................................................................................... 9
Policy Options ............................................................................................................................... 10
Advance the Tax Credit ..................................................................................................................11
Modify the Tax Credit’s Value........................................................................................................11
Modify the Eligibility Criteria....................................................................................................... 12

Figures

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Table 1. Tax Credit Induced Reduction in Absolute Home Prices and Annual
Homeownership Costs By Expected Tenure and Region ............................................................. 7

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Appendix. ...................................................................................................................................... 14

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Author Contact Information .......................................................................................................... 14

˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
—?›˜?žŒ?’˜—ȱ
In the summer of 2008 a first-time homebuyer tax credit was enacted as part of the
comprehensive Housing and Economic Recovery Act of 2008 (P.L. 110-289).1 The American
Recovery and Reinvestment Act of 2009 (ARRA; H.R. 1, P.L. 111-5), as agreed to in conference
and signed into law by the President, recently increased the value of the tax credit for home
purchases in 2009 and extended the period over which the credit applies. The tax credit is
intended to address concern over the excess home inventory and falling home prices.2 Proponents
argue that the tax credit provides households with the necessary incentive to purchase a home,
and will thus reduce excess home inventory and stabilize prices. Opponents of the tax credit
argue, however, that the tax credit may be limited in its ability to achieve its objective for several
reasons. First, the tax credit may only be claimed after a taxpayer purchases a home. Research
indicates that most first-time buyers need assistance prior to, or at the time of, purchase to cover
the down payment and closing costs. Second, the first-time homebuyer tax credit must be repaid
for homes purchased in 2008. Repayment reduces the credit’s effective value and incentive for
homebuyers in 2008 by approximately 60% to 75%.3 Third, it is expected that the economy will
show continued signs of weakness through 2009 which increases the likelihood that buyers will
remain on the sidelines even with the tax credit.4
This report analyzes the potential of the first-time homebuyer tax credit to achieve its intended
objective. The report begins with an overview of current economic conditions. Next, a brief
summary of the tax credit is provided followed by an economic analysis of the credit. The final
section reviews policy options.
ž››Ž—?ȱŒ˜—˜–’Œȱ˜—?’?’˜—œȱȱ
‘Žȱ ˜žœ’—?ȱŠ›”Ž?ȱȱ
The current condition of the housing market stems from a series of events that unfolded over a
number of years. During the early part of this decade residential home sales began to accelerate as
a combination of low mortgage rates and financial market innovations enabled more households
to purchase a home. As more households made the transition into homeownership, the demand for

1 The Housing and Economic Recovery Act of 2008 was intended to strengthen the regulation of Freddie Mac and
Fannie Mae, modernize the Federal Housing Administration, and provide assistance for homeowners unable to pay
their current mortgage. For more information on the act see, CRS Report RL34623, Housing and Economic Recovery
Act of 2008, by N. Eric Weiss et al.

2 See for example, Sen. Benjamin L. Cardin, Congressional Record, vol. 154, no. 52 (April 3, 2008), p. S2419, Sen.
Max Baucus, Congressional Record, vol. 154, no. 124 (July 26, 2008), p. S7501, and Sen. Ken Salazar, Congressional
Record, vol. 154, no. 123 (July 25, 2008), p. S7457.
3 The effective value of the tax credit is measured as the amount of the tax credit minus the present value of the stream
of repayments. The present value of the stream of repayments depends on the number of years a buyer expects to
remain in the home. The range cited above represents a 6 year and a 16 year expected tenure. A complete discussion of
the credit’s value is presented later in this report.
4 Federal Reserve Bank of Chicago, “U.S. Economic Growth Will Be Weak In 2009, Chicago Fed Economic Outlook
Symposium Participants Say,” press release, December 8, 2008, http://www.chicagofed.org.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŗȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
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owner-occupied housing began to exceed supply. The increased demand for home purchases
placed upward pressure on real estate prices.
In response to higher prices and enhanced profit margins, homebuilders increased home
production. With the expectation of higher future home prices, due in part to speculation, the
increased supply of homes on the market began to exceed demand. Homebuilders soon faced a
large inventory of unsold homes. Home inventory increased further as interest rate resets on
adjustable rate mortgages (ARMs) and an increasing number of upside-down borrowers (i.e.,
those who owe more on a home than it was worth) led to a rise in the number of foreclosures. By
November 2008 (the most recently available data), the new and existing home inventories stood
at 11.5 months and 11.2 months, respectively, while a 5.0 month inventory has been, historically,
considered more normal.5 Deteriorating economic conditions exerted a separate negative effect on
the housing market in areas of the country that were originally isolated from the housing bubble.
Regional markets have been impacted differently by the downturn in housing. States such as
Arizona, California, Florida, and Nevada experienced the most dramatic increase and subsequent
decrease in prices. For example, home prices in Phoenix, Los Angeles, San Francisco, San Diego,
and Miami have fallen more than 30% from their 2006 peak according the S&P/Case-Shiller
Home Price Index. These cities have also been left with some of the largest inventories of unsold
homes. Other areas such as Detroit were initially less affected by turmoil in the mortgage market.
Still, home prices there have fallen nearly 29% from their 2006 high as the result of significant
job loss and a reduction in population. At the same time, home prices in some areas of the
country, such as Charlotte and Dallas, have remained relatively stable.
Conditions in the housing market could deteriorate further over the next two years as a number of
pay-option adjustable rate mortgages, also known as option ARMs, are set to be recast. An option
ARM mortgage provides the borrower with several monthly payment options for a specified
number of years. At the end of the specified period the mortgage is “recast” and payments
increase to ensure repayment by the time the loan matures. Recast can occur earlier if the
borrower’s monthly payments are less than accrued interest. The difference between the monthly
payment and the interest only payment is added to the outstanding principal. When the
outstanding principal grows to a predetermined amount of the original balance the mortgage is
recast and payments increase. Fitch Ratings estimates $29 billion in option ARM mortgages will
be recast in 2009, followed by another $67 billion in 2010.6 Fitch Ratings also estimates that
monthly payments on recast mortgages could increase $1,053, or 63%. The increased monthly
payments could translate into higher default rates, which would add to the home inventory and
put downward pressure on home prices
‘Žȱ›˜Š?Ž›ȱŒ˜—˜–¢ȱ
The weakness in the housing market has contributed to, and has been reinforced by, weakness in
the overall economy. Household wealth, a large portion of which consists of home equity, has

5 The housing inventory expressed in monthly terms indicates how long the current quantity of homes on the market
would take to sell off at the current rate of sales. Home inventory statistics are published by two different organizations.
The National Association of Realtors reports the existing home inventory, while the U.S. Census Bureau reports the
new home inventory.
6 Fitch Ratings, Option ARMs: It’s Later Than It Seems, New York, NY, September 2, 2008, pp. 1-6,
http://www.fitchratings.com.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
Řȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
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been reduced due to falling home prices. As a result, consumer spending and borrowing have
decreased which has directly affected aggregate economic activity. At the same time,
deteriorating employment conditions have adversely affected the ability of some owners to make
mortgage payments, therefore contributing to home foreclosures and falling home prices. Banks
and financial institutions worried about the ability of borrowers to repay and already suffering
large losses have been hesitant to extend credit to consumers and each other. State and local
governments’ budgets have become strained as falling home prices have reduced the ability to
raise revenue through property taxes.7
‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?ȱ
First-time homebuyers in 2009 are allowed a credit against their federal income tax equal to a
maximum of 10% of a home’s purchase price, or $8,000.8 The credit amount is limited to $7,500
for homebuyers in 2008. The amount of the credit that may be claimed is reduced for individuals
with modified adjusted gross income (AGI) of more than $75,000 ($150,000 for joint filers), and
is zero for those individuals with modified AGI in excess of $95,000 ($170,000 for joint filers).9
To qualify for the credit the buyer must not have had an interest in a principal residence in the last
three years. 10 In addition, the home must be purchased no earlier than April 9, 2008, and no later
than November 30, 2009.
The tax credit is refundable, which allows lower-income households with little or no tax liability
to take full advantage of the credit. For example, consider a first-time homebuyer who owes
$5,000 in income taxes. Assuming the buyer and the home purchase qualify for an $8,000 tax
credit, the buyer’s tax liability will be reduced to zero and, in addition, the buyer will receive a
$3,000 refund check from the Treasury.
Taxpayers that purchase a home in 2008 must repay the tax credit in equal installments over 15
years beginning in the second taxable year after the purchase of a home. The repayment
requirement is waived for home purchases made in 2009 unless the home is sold within three
years of purchase. Given that interest does not accumulate during the repayment period, the
repayable tax credit equates to an interest free loan with a 16-year repayment period (a 1-year
grace period plus 15 years of payments). The annual repayment is equal to 1/15th the amount of

7 For a more detailed report on the current state of the economy see CRS Report R40104, Economic Stimulus: Issues
and Policies, by Jane G. Gravelle, Thomas L. Hungerford, and Marc Labonte.
8 For a more detailed discussion on the technical aspects of the tax credit see CRS Report RL34664, The First-Time
Homebuyer Tax Credit, by Carol A. Pettit.
9 The reduced credit for an individual with a modified AGI between $75,000 and $95,000 may be determined using the
following general formula provided (in written form) in P.L. 110-289:
(
) ⎛
Modified AGI − $75,000 ⎞
Tax credit = $7,500 or 10% of price × ⎜1 −
⎟
$20,000
⎝
⎠
Joint filers with modified AGI between $150,000 and $170,000 could determine the amount of the reduced credit they
are eligible for by replacing $75,000 with $150,000 in the formula above. For the purposes of the homebuyer tax credit,
modified AGI is defined as adjusted gross income plus foreign earned income.
10 Principle residence is not defined explicitly in the Internal Revenue Code (IRC) section that created the tax credit.
For a more detailed discussion on this issue see CRS Report RL34664, The First-Time Homebuyer Tax Credit, by
Carol A. Pettit. Taxpayers who are allowed the District of Columbia’s homebuyer tax credit are not allowed the first-
time homebuyer tax credit.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
řȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
the original tax credit. Should the home be sold or no longer used as the owner’s principal
residence, the entire tax credit is to be repaid in the tax year when such change in use of the
property occurs. The recaptured amount may not exceed any gain realized by the sale of the
house.
An eligible purchase made in 2009 may be treated for tax purposes as having occurred on
December 31, 2008. This allows homebuyers who purchase their home in 2009 to receive the
benefit of the tax credit more quickly by either claiming the purchase on their 2008 tax return (if
the purchase is made prior to filing the 2008 return), or by filing an amended 2008 tax return (if
the purchase is made after filing the 2008 return).
Œ˜—˜–’Œȱ—Š•¢œ’œȱ˜?ȱ?‘ŽȱŠ¡ȱ›Ž?’?ȱ
The economic analysis presented below is organized as follows. First, the administrative aspects
of the tax credit and its ability to target marginal first-time buyers are examined. Next, the
reduction in the cost of homeownership induced by the tax credit is estimated and is followed by
an estimate of how responsive households are to the reduction. The ability of the tax credit to
stimulate new home purchases given the current economic environment is also discussed. Lastly,
a brief comparison of the new national first-time homebuyer tax credit with the D.C. first-time
homebuyer tax credit is made.
Š›?’—Š•ȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›œȱ
If the first-time homebuyer tax credit is to be effective at stimulating new home purchases it will
need to target marginal homebuyers. Marginal homebuyers are households who, absent the tax
credit, would not purchase a home, but as a result of the tax credit choose to purchase a home. As
a result, the home purchase decisions of marginal buyers are directly influenced by the tax credit.
A tax credit that targets marginal homebuyers carries with it the greatest potential for spurring
new home demand. Alternatively, there exists those homebuyers that are not on the margin. These
households are either unable or unwilling to purchase a home even with the tax credit, or would
purchase a home even without the tax credit. The home purchase decisions of these taxpayers are
not directly influenced by the tax credit and do not represent new home demand.11
Administratively, the first-time homebuyer tax credit may not be able to induce marginal buyers
to purchase a home. A home purchase is a relatively high cost transaction, requiring a purchaser
to make an equity contribution in the form of a down payment and pay closing costs and
settlement fees. The high transaction cost associated with purchasing a home, or more specifically
the necessity that a buyer hold an adequate amount of (liquid) wealth to cover such cost, has been
identified by economists as the primary barrier to homeownership.12 Because the tax credit may

11 While a tax credit may not influence a non-marginal buyer’s decision to purchase a home, it may influence their
decision about which home to purchase. For example, the extra money from a tax credit may lead to the purchase of
larger homes.
12 See for example, Peter D. Linneman and Susan M. Wachter, “The Impacts of Borrowing Constraints on
Homeownership,” Journal of American Real Estate and Urban Economics Association, vol. 17, no. 4 (Winter 1989),
pp. 389-402, and Donald R. Haurin, Patrick H. Hendershott, and Susan M. Wachter, “Borrowing Constraints and the
Tenure Choice of Young Households,” Journal of Housing Research, vol. 8, no. 2 (1997), pp. 137-154.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
Śȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
not be claimed until after a home has been purchased, the tax credit does little to address this
barrier. Allowing households to treat a home purchase in 2009 as having occurred during the 2008
tax year in order to more quickly receive the tax credit still requires the household to first
purchase the home.
The need to allow for advanced payment of a tax credit has been recognized by policy makers
working in other areas. For example, the earned income tax credit (EITC) and the health care
coverage tax credit (HCTC) allow eligible taxpayers to claim at least a portion of their credits in
advance. Recent proposals for a higher education tax credit have also included proposals for an
advance payment. Allowing for a tax credit to be advanced may, however, be complex and costly.
A more detailed discussion of an advanced homebuyer tax credit is provided below when policy
options are reviewed.
‘Žȱ˜œ?ȱ˜?ȱ ˜–Ž˜ —Ž›œ‘’™ȱ
The effectiveness of the first-time homebuyer tax credit also depends on the amount by which it
reduces the relative cost of homeownership and how responsive households are to the reduction.
A household will be more likely to purchase a home when the cost of homeownership falls
relative to renting. The larger is the reduction in the cost of homeownership caused by the tax
credit, the greater the effect the will be on home demand. At the same time, the more responsive
households are to a given reduction, the greater the effect the tax credit will have. Thus, analyzing
the homebuyer tax credit requires an estimate of how much it reduces the cost of ownership.
Existing research can then be used to estimate how responsive buyers are to a given cost
reduction.
Š¡ȱ›Ž?’?ȱ —?žŒŽ?ȱ›’ŒŽȱŽ?žŒ?’˜—ȱ
The first-time homebuyer tax credit effectively reduces the purchase price of a home, but for
homebuyers in 2008 the reduction is less than the dollar amount of the credit. For these tax credit
recipients, the reduction in a home’s purchase price is less than the dollar value of the credit
(maximum $7,500) because the tax credit must be repaid. The tax credit still reduces the price of
owner-occupied housing even though it must be repaid because there are no interest charges
during the repayment period. For homebuyers in 2009, the tax credit effectively reduces the
purchase price of a home dollar for dollar (maximum $8,000).
Economic theory provides a straightforward approach—known as the net present value (NPV)
method—for determining by how much the tax credit reduces the purchase price of a home when
it must be repaid. Use of the NPV method begins by converting future tax credit repayments into
“present values” through a process known as discounting, which requires the use of a discount
rate. The present value of future repayments are then deducted from the tax credit to arrive at an
estimate of the credit’s economic value. The economic value of the tax credit is effectively the
amount by which the tax credit reduces the purchase price of a home.
Which discount rate to use in the NPV calculation is critical because of the role it plays in the
valuation. The discount rate should be chosen to reflect the rate of return on alternative
investments. Arguably, this cost is best summarized by a mortgage interest rate as the household
could take the credit and reduce their mortgage. In the end, the higher are mortgage interest rates,
the more valuable the tax credit.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
śȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
The length of time a household expects to remain in their home is also an important factor, as the
NPV of the tax credit will be smaller for those homebuyers that expect to move before the end of
the repayment period. Essentially, moving prevents the homebuyer from taking full advantage of
the interest free repayment. Under current law, a household must repay the tax credit over a 15
year period beginning in the second year after purchasing a home. The one year grace period
before a buyer is required to start repaying implies that the effective repayment period is 16 years.
A buyer who moves prior to the end of the 16 year repayment period is required to repay in full
the remainder of that tax credit. According to the most recent data, the average first-time
homebuyer only expects to stay in his or her first home for six years.13 Therefore, the actual
repayment period for the average first-time homebuyer is significantly less than 16 years.
The maximum $7,500 tax credit is estimated to reduce the purchase price of a home bought in
2008 by between $1,877 and $3,086 depending on the buyer’s expected tenure. This estimate
assumes a discount (mortgage) rate of 6.5% and expected tenure lengths of 6 years and 16 years,
respectively. The range for the tax credit’s value reflects the notion that the longer a buyer
remains in the home, the longer they have to take advantage of the interest free repayment. The
tax credit’s value would increase if a higher mortgage rate were assumed. The value increases
because the tax credit could be used to reduce the amount owed on a higher interest rate
mortgage. As mentioned above, for homes purchased in 2009, the credit reduces the purchase
price by the amount of the credit, regardless of tenure or mortgage rates. In the example just
discussed the home price reduction would be $8,000.
——žŠ•ȱ˜œ?ȱ˜?ȱ ˜–Ž˜ —Ž›œ‘’™ȱ
While the tax credit effectively reduces the absolute price of a home, its effect on the annual cost
of homeownership is the determining factor for a marginal first-time buyer. The reason for this is
that a potential buyer has the option of continuing to rent. Therefore, a method is needed to
translate the absolute price of a home into an annual cost which can then be compared to annual
rental rates. This task is non-trivial as the total annual cost of owning a home involves more than
simply its purchase price. Financing, maintenance, and depreciation costs, as well as property
taxes, all add to the cost of owning a home. At the same time, a number of benefits such as the tax
deductibility of mortgage interest and property taxes, as well as home price appreciation reduce
the cost of owning a home.
A popular approach used to estimate the annual cost of owning a home is the user cost
framework. The user cost approach allows one to measure the total cost of owning (using) a
house for one year by incorporating the direct costs of homeownership, while also adjusting for
the benefits of homeownership. The user cost approach produces an estimate of the imputed
rental rate of an owner-occupied home. It is the rental rate an owner-occupied home would
command on the rental market.
Although there are several variations of the user cost formula they all express the same
fundamental relationship which may be summarized compactly as:

13 National Association of Realtors, The 2006 National Association of Realtors Profile of Home Buyers and Sellers,
Chicago, IL, 2006.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
Ŝȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ

where P is the home’s purchase price, r is the mortgage rate, tp are property taxes, δ is
depreciation, and m are maintenance costs.14 The tax credit reduces a home’s purchase price, and,
as a result, reduces the annual cost of owning a home. Mortgage interest and property taxes are
deductible. Taking this into account, the net effect on the cost of homeownership is then (1- ty )( r
+ tp ), where ty is the taxpayer’s marginal income tax rate. A premium β has been incorporated to
account for the risk associated with investing in housing. Finally, the cost of homeownership is
reduced (increased) if the expected rate of home appreciation g is positive (negative). The sum of
the latter terms is the user cost and represents annual unit (dollar) cost of owning a home.
Table 1. Tax Credit Induced Reduction in Absolute Home Prices and Annual
Homeownership Costs By Expected Tenure and Region

6 Year Expected Tenure
16+ Year Expected Tenure

Midwest
N. East
South
West
Midwest
N. East
South
West
Median Home Price
December 2008
$140,800 $235,000 $158,600 $213,100 $140,800 $235,000 $158,600 $213,100
Tax Credit Induced
Price Reduction ($)
$1,877 $1,877 $1,877 $1,877 $3,086 $3,086 $3,086 $3,086
With Repayment
Tax Credit Induced
Price Reduction ($)
$8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000
Without Repayment
Annual Cost of Homeownership:
Without
Tax
Credit $9,610 $16,039 $10,824 $14,544 $9,610 $16,039 $10,824 $14,544
With Repayable Tax
Credit
$9,481 $15,911 $10,696 $14,416 $9,399 $15,828 $10,614 $14,333
Reduction
(%) 1.33% 0.80% 1.18% 0.88% 2.19% 1.31
% 1.95% 1.45%
With Non-Repayable
Tax Credit
$9,064 $15,493 $10,278 $13,998 $9,064 $15,493 $10,278 $13,998
Reduction
(%) 5.68% 3.40% 5.04% 3.75% 5.68% 3.40% 5.04% 3.75%
Source: Author’s calculations, National Association of Realtors (preliminary estimates for December).
Notes: The median home prices listed in Table 1 are for existing single-family homes. The U.S. Census Bureau
reports median new home prices. For several reasons, the available existing and new home data are not directly
comparable.

14 The user cost formula used above is from James M. Poterba, “Taxation and Housing: Old Questions, New Answers,”
American Economic Review , vol. 82, no. 2 (May 1992), pp. 237-242. Other variations of the user cost formula may be
found in James M. Poterba, “Tax Subsidies to Owner-Occupied Housing an Asset-Market Approach,” The Quarterly
Journal Of Economics, vol. 99, no. 4 (November 1984), p. 729-752 and Charles Himmelberg, Christopher Mayer, and
Todd Sinai, “Assessing High Housing Prices: Bubbles, Fundamentals, and Misperceptions,” Journal of Economic
Perspectives, vol. 19, no. 4 (Fall 2005), pp. 67-92.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŝȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
Given the estimated tax credit induced price reduction from the previous section, the user-cost of
housing method was used to estimate the annual cost of homeownership, with and without the tax
credit.15 Table 1 presents the estimation results, stratified by geographic region and expected
tenure. The top panel of Table 1 displays existing single-family median home prices as of the
December of 2008 and the amount of the tax credit induced price reduction. Note that the dollar
reduction in home prices stemming from the tax credit is constant across geographic region for
households with the same expected tenure since median home prices always exceed $80,000.16 As
reported in the previous section, the effective value of the tax credit for homebuyers in 2008 is
estimated to be $1,877 if a household expects to remain in their first home for six years. The
credit’s value increases to an estimated $3,086 if a household expects to remain in the home for at
least 16 years. Also discussed in the previous section was the fact that the value of the tax credit
for homebuyers in 2009 was a constant $8,000.
The bottom panel of Table 1 presents an estimate of the annual cost of owning a home with and
without the repayable and non-repayable homebuyer tax credit. Looking across regions the
estimates show that the tax credit, regardless of if it must be repaid, is more valuable in lower
priced markets. At the high end, the repayable tax credit is estimated to reduce the annual cost of
homeownership by approximately 2.19% (Midwest, 16+ year expected tenure). At the low end
the repayable tax credit is estimated to reduce the annual cost of homeownership by
approximately 0.80% (North East, six year expected tenure). At the high end, the non-repayable
tax credit is estimated to reduce the annual cost of homeownership by approximately 5.68%
(Midwest), while at the low end it is estimated to reduce the annual cost of homeownership by
approximately 3.40% (North East).
To put the size of the tax credit induced price reductions in perspective, consider that the median
existing home price in the U.S. has fallen by 21% since 2006.17 The West region experienced the
greatest decline (38%), the Midwest (16%), followed by the Northeast (15%), and finally the
South (14%).18
ž¢Ž›ȱŽœ™˜—œŽȱ?˜ȱ?‘ŽȱŠ¡ȱ›Ž?’?ȱ
Of equal importance to how much the tax credit reduces the cost of homeownership is how
responsive households are to a given reduction. Economists use the concept of elasticity to
measure how responsive individual behavior is to a given change in prices, taxes, income, and
other economic variables. The elasticity that matters for studying the effectiveness of the first-
time homebuyers tax credit is the tenure-choice price elasticity. This behavioral response measure
indicates the likelihood that a renter will become an owner given a reduction in relative cost of
homeownership. An elasticity of 1 indicates that a 1% decrease in the cost of owning a home
increases the probability a renter becomes an owner by 1 percentage point. The more elastic a
renter’s behavior is the more likely it is that they will become owners.

15 To actually employ the user cost method described above, assumptions had to be made with regard to home prices,
property taxes, depreciation, etc. The appendix lists the assumptions and sources for the assumptions.
16 Recall that the dollar amount of the tax credit is equal to the maximum of 10% of a home’s purchase price, or $8,000.
The $8,000 cap only comes into play when a home’s purchase price exceeds $80,000.
17 National Association of Realtors existing home price data.
18 The median home price for the Northeast increased between 2006 and 2007. The percent change presented in the
body of the report is from 2007 to 2008.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
Şȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
Combining empirical estimates of the tenure-price elasticity with the estimated decrease in the
relative cost suggests that the tax credit may have a small effect on the demand for owner-
occupied housing. Estimates of the tenure-price elasticity, although limited, are approximately
clustered around 1, while the cost reduction stemming from the repayable tax credit is estimated
to be between 0.80% and 2.19%, while the cost reduction for the non-repayable tax credit is
estimated to be between 3.40% and 5.68%.19 Under the assumption that annual cost of owning
and rental are now reasonably close, the first-time homebuyer tax credit could be expected to
increase the probability that the average household purchases a home in 2009 by at most 5.68
percentage points. The estimated home buying response may be overestimated since the tenure-
price elasticity used for the estimate are based on data from a period well before our current
economic environment.
‘Žȱ —?•žŽ—ŒŽȱ˜?ȱ?‘ŽȱŒ˜—˜–¢ȱŠ—?ȱž?ž›Žȱ ˜–Žȱ
›’ŒŽœȱ
While the homebuyer tax credit is predicted to have some effect on home demand, the influence
of economic uncertainty may prove more powerful. Weakness in the labor market as indicated by
rising unemployment points toward an increased risk that a potential homebuyer may have
trouble making mortgage payments. As a result, some households could delay purchasing a home
until the economy improves and employment conditions stabilize. At the same time, any assets
that a household may have set aside for a down payment are likely to have fallen in value
significantly over the last year, reducing the ability to purchase a home.
Expectations over the future path of home prices can also be expected to affect a household’s
decision to buy a home. If homebuyers expect prices to continue to fall they are likely to remain
on the sidelines until a bottom to the housing market begins to be established. Once prices are
perceived to have stabilized and the economy has begun to recover, increased demand for owner-
occupied housing can be expected. It is possible that home prices may not stabilize until after the
homebuyer tax credit expires (July 1, 2009).
‘Žȱǯǯȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?ȱ
There currently exists one other federal tax credit for first-time homebuyers. In an effort to
revitalize city neighborhoods, first-time homebuyers in the District of Columbia have been
allowed a credit against their federal income tax equal to $5,000 since 1997. A first-time
homebuyer is any taxpayer that has had no interest in a principal residence in D.C. within the last
year. Non-D.C. residents, including non-D.C. resident homeowners, are eligible to claim the
credit for a home purchased in the city. Unlike the new homebuyer tax credit, the D.C. tax credit
is non-refundable and need not be repaid. The credit amount is reduced for individuals with

19 See for example, Harvy S. Rosen, “Housing Decision and The U.S. Income Tax: An Econometric Analysis,” Journal
of Public Economics, vol. 11, no. 1 (February 1979), pp. 1-23, or Carol Rapaport, “Housing Demand and Community
Choice: An Empirical Analysis,” Journal of Urban Economics, vol. 42, no. 2 (September 1997), pp. 243-260, or Allen
C. Goodman, “An Econometric Model of Housing Price, Permanent Income, Tenure Choice, and Housing Demand,”
Journal of Urban Economics, vol. 23, no. 3 (May 1988), pp. 327-353.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
şȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
modified AGI of more than $70,000 ($110,000 for joint filers), and is zero for those individuals
with modified AGI in excess of $90,000 ($130,000 for joint filers).
A 2005 Fannie Mae special report found that the D.C. tax credit increased city homeownership
and home prices, and that a large fraction of buyers claimed the credit.20 There are a number of
reason to be cautious, however, about extrapolating the results nation-wide. The environment
during the time period from which the data used in the study were drawn (1997-2001) reflected
economic expansion. Households were purchasing homes because they had job security and a
sense of wealth as the stock market rose. Home buying in D.C. may have also increased faster
than in surrounding suburbs due in part to lower relative prices in the city. A tax credit
administered at the national level leaves relative regional home prices unchanged, and would thus
not be expected to generate such geographically driven purchases.
Unlike the D.C. homebuyer tax credit, the new homebuyer tax credit may not increase property
values in some markets. The stronger the demand is for homes relative to the supply of homes,
the more likely it is that sellers can capture a large portion of the credit by raising their sales
price. At the time the D.C. homebuyer tax credit was introduced, home demand was relatively
strong and home supply relatively tight, which would explain the documented home appreciation
in the city. Currently, however, the demand for homes is relatively weak and the supply of homes
relatively abundant, suggesting there may be little to no upward pressure on home prices as a
result of the tax credit.
The number of homebuyers that claim the homebuyer tax credit may not be indicative of how
effective the tax credit is at stimulating home buying. The Fannie Mae report estimated that the
D.C. tax credit was claimed by approximately 77% of homebuyers between 1999-2001. Any
eligible homebuyer, however, could be expected to claim the tax credit. And given that the new
first-time homebuyer tax credit may not be claimed until after a home purchase, a large fraction
of those claiming the credit probably would have purchased a home anyway.
˜•’Œ¢ȱ™?’˜—œȱ
The first-time homebuyer tax credit is set to expire on December 1, 2009. On the one hand, if the
housing market begins to show strong signs of a recovery Congress may choose to allow the
credit to expire. On the other hand, if housing demand is still weak, Congress may choose to
extend the credit as is, or make modifications. If modifications are considered, several policy
options are available which may be categorized into three general categories. First, the tax credit
could be advanced. Second, the value of the credit may be adjusted, either directly or indirectly.
Third, the criteria used to determine tax credit eligibility may be modified. Specific options
within each of these categories are discussed below. Where applicable, reference to other
homebuyer tax credit proposals made in the 110th Congress are provided as examples.21

20 Zhong Yi Tong, “Washington, D.C.’s First-Time Homebuyer Tax Credit: An Assessment of the Program ,” Fannie
Mae Foundation Special Report, March 2005, pp. 1-44.
21 The examples provided are not intended to be all inclusive. While they are used to illustrate one possible
modification that could be made, the proposed tax credits often differed along other dimensions.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŗŖȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
?ŸŠ—ŒŽȱ?‘ŽȱŠ¡ȱ›Ž?’?ȱ
Restructuring the tax credit rules to allow taxpayers to claim it in advance of a home purchase
would increase the assistance to marginal homebuyers and likely increase the stimulative effect of
the tax credit. As previously mentioned, homebuyers, particularly first-time homebuyers, need
assistance at the time of purchase. The first-time homebuyer tax credit as currently administered,
however, may not be claimed until after a taxpayer purchases a home. As a result, taxpayers
claiming the tax credit may be doing so because they bought a house, not buying a house because
the credit is available.
As mentioned previously, the health care coverage tax credit (HCTC) and the earned income tax
credit (EITC) are examples of two tax credits that permit advanced payment.22 With the HCTC,
eligible taxpayers receive a tax credit equal to 65% of the cost of health insurance. Each month,
taxpayers that would like an advance send the Internal Revenue Service (IRS) a payment equal to
35% of the insurance premium. The IRS then combines the taxpayers payment with the HCTC
and sends the full payment to the taxpayer’s health insurance provider. Eligible workers with at
least one child may have a portion of the EITC advanced to them through their paycheck by
completing a W-5 Form. In 2009, no more than $1,826 may be advanced to a taxpayer through
the EITC program.
Two recent reports by the Government Accountability Office (GAO) indicate that participation in
the advancement programs is low.23 Approximately 3% of eligible EITC participants and 6% of
eligible HCTC participants received advanced payment.24 Several reasons have been offered for
the low participation rates. Some taxpayers may be unaware of the advanced option. Others may
fear they will receive more than they are actually eligible for, thus requiring them to pay back
money at the end of the year. Still others simply find the cost of navigating the complex process,
especially with respect to HCTC, too difficult. Advancing the homebuyer tax credit, perhaps to
the mortgage lender or seller through the IRS thus reducing down payment and closing costs,
would likely be complex as well. As a result, participation in the tax credit program could be
reduced.
˜?’?¢ȱ?‘ŽȱŠ¡ȱ›Ž?’?ȂœȱŠ•žŽȱ
Several possible avenues exist for Congress to modify the first-time homebuyer tax credit’s value.
Three of which are discussed here. First, the face value of the credit itself could be raised or
lowered. For example, in the 110th Congress the original first-time homebuyer tax credit had a
face value of $8,000, while S. 2566 proposed a $15,000 tax credit. Second, the tax credit could be
made non-refundable. Doing so, however, would reduce the tax credit’s value for households with

22 For more information on the HCTC see, CRS Report RL32620, Health Coverage Tax Credit Authorized by the Trade
Act of 2002, by Bernadette Fernandez. For more information on the EITC see, CRS Report RL31768, The Earned
Income Tax Credit (EITC): An Overview, by Christine Scott.
23 See, U.S. Government Accountability Office, Advanced Earned Income Tax Credit: Low Use and Small Dollars
Paid Impede IRS’s Efforts to Reduce High Noncompliance, GA0-07-1110, August 2007, and U.S. Government
Accountability Office, Health Coverage Tax Credit: Simplified and More Timely Enrollment Process Could Increase
Participation, GA0-04-1029, September 2004.
24 Time period of reference for advanced EITC figure was 2002-2004. Time period of reference for advanced HITC
figure was July 2004.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŗŗȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
a tax liability of less than $8,000. Given the fact that tax liability is strongly related to income,
lower income earners would likely be most affected by eliminating the refundable aspect of the
credit. The tax credit proposed in S. 2734 is one example of a non-refundable tax credit.
Third, as was recently done with the American Recovery and Reinvestment Act of 2009, the
repayment requirement could be eliminated which would increase the tax credit’s value to the
credit’s full face value ($8,000 or 10% of the purchase price). As mentioned previously, a
repayable tax credit’s value is reduced below the credit’s face value, although on net it is still
positive. More taxpayers may choose to also claim the credit if they are not required to have the
discipline to ensure they can meet the increased tax liability that stems from repayment.
Homebuyer tax credits proposed in the 110th Congress by S. 12 and H.R. 5670 were non-
repayable.
Modifications that increased the tax credit’s value and allowed for advance payment would likely
provide the greatest amount of stimulus. Marginal homebuyers, defined as that group of
households predicted to be most responsive to a tax credit, often need down payment and closing
cost assistance. Increasing the value of the credit without advancing the tax credit payment fails
to address these two barriers to homeownership. In addition, increasing the tax credit’s value
without advance payment could simply cause non-marginal homebuyers to purchase larger
homes.
˜?’?¢ȱ?‘Žȱ•’?’‹’•’?¢ȱ›’?Ž›’Šȱ
The criteria used to determine eligibility for the tax credit could be modified. Two general ways
that draw on legislation in the 110th Congress are described. First, the definition of eligible
properties could be more narrowly focused. For example, S. 2566 and S. 12 each proposed a
homebuyer tax credit for a home purchase that met one of three criteria: the home was new and
unoccupied; the owner’s mortgage was in default; or the home was in foreclosure. A similar, but
more focused tax credit was proposed by an early version of H.R. 3221 (the American Housing
Rescue and Foreclosure Prevention Act of 2008), which would have been allowed exclusively for
the purchase of a foreclosed home. Most recently, the American Recovery and Reinvestment Act
of 2009 extended the tax credit to homes purchased before December 1, 2009.
Second, the definition of an eligible taxpayers could be modified. One definition would expand
eligibility beyond first-time homebuyers to include current homeowners, as well as renters that
recently have been homeowners. Such a modification would likely increase the number of buyers
who claim the tax credit, although a large fraction the purchases would have likely occurred with
or without the credit.
Additionally, the definition of an eligible taxpayer could be modified by adjusting the limitations
on income. One option would be to eliminate the income eligibility limits altogether. Such a
change could possibly stimulate demand among potential homebuyers that were previously only
eligible for a reduced tax credit. At the same time, eliminating the income limits altogether would
likely result in a number of higher income individuals claiming the credit, although the credit
itself did not influence their decision to purchase a home.
Another option would be to impose an income limit above which taxpayers were ineligible to
receive the credit, but below which all taxpayers received the full credit amount. Adjusting the
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŗŘȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
income limits in this manner could increase use of the tax credit for more individuals whose
decisions are likely to be influenced by the tax credit.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŗřȱ

‘Žȱ’›œ?Ȭ’–Žȱ ˜–Ž‹ž¢Ž›ȱŠ¡ȱ›Ž?’?Ǳȱ—ȱŒ˜—˜–’Œȱ—Š•¢œ’œȱ
ȱ
™™Ž—?’¡ǯ ȱ
This appendix lists the assumptions used in the user cost of capital formula for calculating the
annual cost of homeownership. Recall that the annual cost of homeownership may be estimated
with the following formula:

Given home price data, which was taken from the National Association of Realtors and is listed in
Table 1, the remaining parameters values required for the estimation are: the marginal income tax
rate ty; the mortgage rate r; the property tax rate tp; the home depreciation rate δ; maintenance
costs m; a risk premium for housing investment β; and the rate of home appreciation g.
The marginal income tax rate, the property tax rate, and the mortgage rate were assumed to be
25%, 1%, and 6.5%, respectively. The research of Harding, Rosenthal, and Sirmans (2007) was
used to pin down the depreciation rate and maintenance costs at 2.5% and 0.50%, respectively.25
And Himmelberg, Mayer and Sinai (2005) estimate the housing risk premium to be 2.0% and the
long run home appreciation rate to be 3.8%.26
The estimated home appreciation rate citied above may be too high to apply to the current
housing market and any attempt to adjust this figure downward would likely be arbitrary.
Reducing the home appreciation rate, however, would result in a higher homeownership cost
estimate. As a result, the value of the homebuyer tax credit expressed as a fraction of the annual
ownership cost would fall, reducing the credit’s stimulative effect.

ž?‘˜›ȱ˜—?ŠŒ?ȱ —?˜›–Š?’˜—ȱ

Mark P. Keightley

Analyst in Public Finance
mkeightley@crs.loc.gov, 7-1049

25 John P. Harding, Stuart S. Rosenthal, and C.F. Sirmans, “Depreciation of Housing Capital, Maintenance, and House
Price inflation: Estimates From a Repeat Sales Model,” Journal of Urban Economics, vol. 61, no. 2 (March 2007), pp.
193-217.
26 Charles Himmelberg, Christopher Mayer, and Todd Sinai, “Assessing High House Prices: Bubbles, Fundamentals,
and Misperceptions,” Journal of Economic Perspectives, vol. 19, no. 4 (Autumn 2005), pp. 67-92.
˜—?›Žœœ’˜—Š•ȱŽœŽŠ›Œ‘ȱŽ›Ÿ’ŒŽȱ
ŗŚȱ