Kevin A. Bryan is an assistant professor of strategic management at the University of Toronto’s Rotman School of Management
John Pasalis is president of Realosophy Realty in Toronto
Housing is increasingly unaffordable in Canada, particularly in Toronto and Vancouver. A centrepiece of the 2019 federal budget is a package of housing policy changes including the First Time Home Buyer Incentive. Effectively, Ottawa will pay up to 10 per cent of the mortgage in exchange for home equity, reducing mortgage payments for first-time buyers. The program is limited to mortgages up to four times a buyer’s annual income, with a cap of $120,000.
Does this policy make sense given the government’s stated goals? There are several economic questions here: Does this plan reduce home prices for first-time buyers? Does this plan increase home ownership? Is this plan equitable? Is this a “free lunch” in terms of taxpayer-held risk? And does this policy fix an economic distortion in the housing market? Our read of the economic evidence from similar policies is a qualified “no” on all counts.
First, prices. Assume the government offered a hockey fan a 10-per-cent discount on an NHL ticket. The fan is clearly better off. But is she better off if the government offers all hockey fans the same discount for a game that would otherwise sell out? These fans will use the subsidy to bid up the price of the tickets. The difference is what economists call "partial equilibrium” versus “general equilibrium.” The partial equilibrium of the home-buyer incentive is clear: The government is directly reducing mortgage payments. The general equilibrium is much less obvious. The incentive lowers mortgage payments for all potential first-time home buyers, and the income cap means that in our most expensive cities, only the condo market is cheap enough to be affected. Demand for these properties will therefore increase, pushing prices back up. If housing supply is constrained, the effect is stark: The subsidy is entirely capitalized into rising home prices.
Second is the question of home-ownership rates. If the subsidy is capitalized into home prices, then, unsurprisingly, home-ownership rates do not change. Economists studying the U.S. mortgage interest deduction, a much larger and more broad-based subsidy, find near zero effects on overall home ownership. Even if housing supply were not constrained, the policy will not change home-ownership rates if most buyers receiving the incentive would have bought their house even without the incentive.
Third, and related, is the question of equity. Housing-assistance programs that condition the size of the subsidy on income unsurprisingly benefit the well-off the most. A family earning the median Canadian income of roughly $60,000 gets half the effective subsidy as one at the income cap. Further, those closer to the cap are more likely to have the down payment and future income to support purchasing a house, hence are more likely to use the program. The benefits of the program therefore tilt toward the well-off.
Fourth is the question of risk. The government is taking 10 per cent of the purchased home’s equity, shifting part of the risk of a downturn in house prices from the home buyer to the taxpayer. Private shared-equity programs exist, such as those run by California’s Unison. They allow potential homeowners to slough off the upside and downside risk of home ownership if they merely want “a place to live” rather than a place to live combined with the investment aspects of owning a home. The government’s role when private firms do not want to provide shared equity is less clear: Rather than shifting the risk of ownership to investors, public shared equity shifts that risk to taxpayers at large.
Finally, there is the question of what economic distortion is being addressed. Communities with higher home ownership have many benefits, from lower crime to better educational outcomes for children. However, the policy in question is unlikely to increase home ownership. High house prices mean lower real income, a binding problem for young people early in their careers. But public equity sharing will not affect out-of-pocket housing costs in our major, supply-constrained cities. And indeed, if growing real inequality is the problem we want to address, we can do that directly with cash transfers in the tax system, rather than a convoluted housing scheme. To put it simply: It is not clear what problem is being solved with shared equity, and even less clear that any of the potential problems actually are solved.
What would a better housing policy look like? Some aspects of solid housing policy exist in other areas of the budget. The RRSP withdrawal limit for first-time buyers increases to $35,000 from $25,000. An additional $10-billion over nine years will go toward low-cost loans for the construction of new rental housing. Dedicated real estate audit teams will be set up to help deter financial crimes in real estate. Allowing buyers to use savings rather than debt, increasing housing supply, and limiting fraud, have clear benefits. Indeed, the best housing-policy decision was the one not implemented. It was widely expected the maximum amortization on insured mortgages would be increased to 30 years from 25. Such a policy allows buyers to take on more debt while keeping their payments constant, a potential macroeconomic disaster given Canada’s already high levels of household debt.