Habitat for Market Failure
There is a very interesting story in yesterday’s Washington Post by Annie Gowen (who did not ask enough tough questions to Habitat for Humanity). The story is about Mrs. Kesha James and her struggles to keep her Alexandria home in the face of rising property taxes:
Habitat for Humanity of Northern Virginia is a charity devoted to providing affordable housing to low-income families. The important points of this article were highlighted at a post at Crooked Timber, (there is a very nice thread of the issues and I put in my 2 cents worth as well and was not well received).
Let me briefly outline the issues in the story.
Real estate prices across the United States have increased in the last five years due to falling interest rates, but the increase has been especially large in Northern Virginia. The real estate tax in Fairfax, Virginia (where I live) is 1.13% of the assessed value of the property. That rate has not changed since 1999 when I came to Fairfax County. So naturally, the amount of real estate tax revenue must have doubled in the last five years, (actually more than doubled since new homes have been built). So that begs the question: have county expenses more than doubled in the last five years? The answer is “yes” only in the sense that the board of supervisors must have figured out some way to spend all of this revenue because they have certainly not refunded any of it.
This is a classic example of government rent-seeking behavior. Politicians like to spend other people’s money (OPM). It is more fun to spend OPM than spending their own money because they didn’t have to earn it. Rebating the excess revenue generated by rising real estate prices risks causing a future shortfall in future revenues if those real estate price later fall. It is easier, and much more fun, to find some way to spend all the extra revenue in the short run. One could hope that the politicians are using this revenue to build lots of new buildings for schools and police stations and other government facilities. I do notice some new construction at the various recreation centers that the county runs, but there is always a need to refurbish a fraction of the buildings even with constant revenue. My guess is you would have to enter the offices of the board of supervisors to find where this excess revenue was spent.
It would make more sense to peg taxes to total county income than real estate rates. Local governments could still tax real estate, but they would first deflate the tax rate for real estate inflation and then inflate the tax rate for an increase in total county income. In this way, a fixed fraction of the local income would always be available for government services. It really wouldn’t be very difficult to make that change, but it would mean less revenue for the county and the politicians wouldn’t like it. Of course, whose utility is more important: politicians’ or taxpayers’?
On surface of it, the claim that Mrs. James deserves a special tax reduction is wholly without merit. The claim is that the restrictive covenant reduces the value of the home. This is absurd. The home is obviously worth about the same as other homes in the neighborhood. If Mrs. James forfeited her home, Habitat for Humanity would then be free to sell it for full market value. The restrictive covenant means that the home is worth less than market value to Mrs. James alone but collectively Mrs. James and Habitat for Humanity definitely own a home that could be sold in a months time for full market value (maybe $500,000). Since Habitat for Humanity and Mrs. James are effectively co-owners during the 20-year restrictive covenant, one could argue that the tax burden could be divvied up between the two. However, the original sale agreement specified that Mrs. James would be responsible for the tax, and that is the end of the argument.
If Habitat for Humanity had originally agreed to take on a portion of the tax bill, they might have been able to claim a rate reduction for their portion of the tax because Habitat for Humanity is a charity. However, the local government still has the discretion to deny any petition of tax abatement. In this case, Habitat for Humanity’s claim would be weak because the real estate is not being used as a collective good for everyone in the local area. It is only being used as a private residence for a low-income household, and low-income households get no tax abatement.
As we will see, this story illustrates why it is not a good idea to grant charitable organization a special tax break. Before 1999, Fairfax County did not provide any special tax considerations for charities. There is a great quote from the introduction a book by Evelyn Brody of the Urban Institute titled “Property Tax Exemption for Charities”:
There is a much more important why no special tax abatement should be granted in this case: it isn’t at all necessary. If Mrs. Jones owned the home with no restrictions, she could apply for a home equity loan and use those funds to pay the real estate taxes and make necessary repairs to the home. The Washington Post quote above shows that the second issue is very relevant: Mrs. James can’t even afford to fix a leak in her living room. Even with the restrictive covenant, Mrs. James could still get the home equity loan if Habitat for Humanity co-signed the loan. Why wouldn’t Habitat for Humanity help Mrs. James when they set her up for her financial problems by placing her in a home that was way more expensive than what she could ordinarily afford? The cynical answer is that Habitat for Humanity would prefer to lobby the local governments to reduce the taxes (and effectively subsidize Habitat for Humanity’s operations) than to help Mrs. James pay the taxes by herself.
The core of the problem illustrated in the Washington Post article is a sad uncooperative game being played by Habitat for Humanity and Mrs. James. It is a game that squanders the potential bonus of the rising real estate value of Mrs. James’ home. Habitat for Humanity wants to do what is impossible: produce affordable housing in Northern Virginia. It is impossible because demand for housing, even lousy housing, is so strong in this area that any home is very valuable, and therefore very unaffordable. Habitat for Humanity tries to fight the market by selling the home at well below market value. But if the owner were to simply resell the home, Habitat for Humanity would have produced no new affordable housing in the area. So Habitat for Humanity restricts the resale of the home so that the homeowner is forced to live in the “gift” house. Although the article did not mention it, I would guess that Habitat for Humanity restricts the owner from renting out the house because this would also defeat Habitat for Humanity’s purpose of producing affordable housing. So the net result of the restrictions is that a potentially valuable home is made much less valuable to the owner. But this destruction of value serves the purpose, ironically, of attracting labor to Habitat for Humanity’s enterprise because they can then point to all of the low-income housing that they have produced in the area. Habitat for Humanity participates in the production of the poverty of their homeowners because it doesn’t serve Habitat for Humanity interests to help these people get wealthy on these homes that they did very little to earn.
It isn’t entirely clear, however, why Habitat for Humanity would not want to co-sign a home equity loan for purpose of doing necessary repairs and for alleviating some of the burden caused by increasing taxes. They could be paternalistic and insist that the homeowner only borrow exactly what she needs. Habitat for Humanity could insist that the homeowner pay them a cut of the loan to help buy other properties to renovate. It could be that Habitat for Humanity volunteers would be turned off by the discovery that owners and Habitat for Humanity were making deals. People won’t volunteer their hard labor to make other people wealthy. But this should not mean that no deals at all are possible between Habitat for Humanity and the homeowners. After all, Mrs. James is not going to be wealthy because of a small home equity loan to pay for the leak in her living room and her $5000 tax bill. It is a sad example of how a charity can be oddly indifferent to the suffering that their rules have brought upon the very people they claim to want to aid.
Habitat for Humanity should reconsider their incentive compatibility issues. They want to make sure that the homeowners are “deserving.” But who deserves a below market home? Maybe the Habitat for Humanity volunteers do. Suppose Habitat for Humanity instituted a rule that these homes only go to volunteers who have worked with Habitat for Humanity for at least 2000 hours (up from a minimum of 300 hours). They would then be giving valuable human capital skills to the poor, increasing their labor force, and making sure the new owners deserved these homes. Then, there would be less ill will toward those who used a home equity loan against their “gift” home for bettering their lives.
Kesha James still remembers walking through the freshly painted rooms of her Habitat for Humanity house for the first time, making plans for the leather couch she would buy, and the piano and the canopied bed for her three little girls.
Today, the couch is still a dream. The living room is in ruins because of a plumbing leak she can't afford to fix. She took a second job and works seven days a week but is still afraid she might lose her house.
Habitat for Humanity of Northern Virginia is a charity devoted to providing affordable housing to low-income families. The important points of this article were highlighted at a post at Crooked Timber, (there is a very nice thread of the issues and I put in my 2 cents worth as well and was not well received).
Let me briefly outline the issues in the story.
- Property values in Northern Virginia (City of Alexandria, Arlington County, Fairfax County, and maybe further counties) have doubled in the last five years.
- Real estate taxes in this region average about 1% of the assessed home value ( not the sale price), so they have naturally doubled as well.
- Habitat for Humanity homes are sold 50% to 75% below market value and have a 20 year zero percent loan. (Nice.)
- Habitat for Humanity places a restrictive covenant on the sale of the home during the 20 year loan period that effectively means the owner forfeits the house and Habitat for Humanity refunds any payments made with no accrued interest if the owner wants to sell the home for any reason.
- The rising real estate taxes combined with the restrictive covenants have put Mrs. James and other Habitat for Humanity home owners on the brink of financial ruin.
- Habitat for Humanity is lobbying the local government in Northern Virginia for abatement of these property taxes, claiming that the restrictive covenants mean that the homes are not worth the assessed value.
- should real estate taxes be rising so rapidly in Northern Virginia?
- do Habitat for Humanity homeowners deserve a partial reduction in their real estate taxes?
Rising real estate taxes
Real estate prices across the United States have increased in the last five years due to falling interest rates, but the increase has been especially large in Northern Virginia. The real estate tax in Fairfax, Virginia (where I live) is 1.13% of the assessed value of the property. That rate has not changed since 1999 when I came to Fairfax County. So naturally, the amount of real estate tax revenue must have doubled in the last five years, (actually more than doubled since new homes have been built). So that begs the question: have county expenses more than doubled in the last five years? The answer is “yes” only in the sense that the board of supervisors must have figured out some way to spend all of this revenue because they have certainly not refunded any of it.
This is a classic example of government rent-seeking behavior. Politicians like to spend other people’s money (OPM). It is more fun to spend OPM than spending their own money because they didn’t have to earn it. Rebating the excess revenue generated by rising real estate prices risks causing a future shortfall in future revenues if those real estate price later fall. It is easier, and much more fun, to find some way to spend all the extra revenue in the short run. One could hope that the politicians are using this revenue to build lots of new buildings for schools and police stations and other government facilities. I do notice some new construction at the various recreation centers that the county runs, but there is always a need to refurbish a fraction of the buildings even with constant revenue. My guess is you would have to enter the offices of the board of supervisors to find where this excess revenue was spent.
It would make more sense to peg taxes to total county income than real estate rates. Local governments could still tax real estate, but they would first deflate the tax rate for real estate inflation and then inflate the tax rate for an increase in total county income. In this way, a fixed fraction of the local income would always be available for government services. It really wouldn’t be very difficult to make that change, but it would mean less revenue for the county and the politicians wouldn’t like it. Of course, whose utility is more important: politicians’ or taxpayers’?
Tax abatement
On surface of it, the claim that Mrs. James deserves a special tax reduction is wholly without merit. The claim is that the restrictive covenant reduces the value of the home. This is absurd. The home is obviously worth about the same as other homes in the neighborhood. If Mrs. James forfeited her home, Habitat for Humanity would then be free to sell it for full market value. The restrictive covenant means that the home is worth less than market value to Mrs. James alone but collectively Mrs. James and Habitat for Humanity definitely own a home that could be sold in a months time for full market value (maybe $500,000). Since Habitat for Humanity and Mrs. James are effectively co-owners during the 20-year restrictive covenant, one could argue that the tax burden could be divvied up between the two. However, the original sale agreement specified that Mrs. James would be responsible for the tax, and that is the end of the argument.
If Habitat for Humanity had originally agreed to take on a portion of the tax bill, they might have been able to claim a rate reduction for their portion of the tax because Habitat for Humanity is a charity. However, the local government still has the discretion to deny any petition of tax abatement. In this case, Habitat for Humanity’s claim would be weak because the real estate is not being used as a collective good for everyone in the local area. It is only being used as a private residence for a low-income household, and low-income households get no tax abatement.
As we will see, this story illustrates why it is not a good idea to grant charitable organization a special tax break. Before 1999, Fairfax County did not provide any special tax considerations for charities. There is a great quote from the introduction a book by Evelyn Brody of the Urban Institute titled “Property Tax Exemption for Charities”:
Who was this dissenting county supervisor? He or she gets my vote!
[The] Fairfax County, Virginia, board of supervisors recently amended guidelines to permit national charities, as well as local ones, to apply for property-tax exemption. In December 1999, the board approved exemption, worth over $300,000 a year, to the National Wildlife Federation, which has an annual budget of $82 million. One county supervisor praised the Federation for being a good citizen by providing local environmental and educational programs. A dissenting supervisor, however, contended, "We're just giving away tax payer money to an organization that doesn't need it and shouldn't get it.... I'm delighted they do what they do, and I'm delighted they're in Fairfax County. And I think, like everybody else, they ought to pay their taxes."
There is a much more important why no special tax abatement should be granted in this case: it isn’t at all necessary. If Mrs. Jones owned the home with no restrictions, she could apply for a home equity loan and use those funds to pay the real estate taxes and make necessary repairs to the home. The Washington Post quote above shows that the second issue is very relevant: Mrs. James can’t even afford to fix a leak in her living room. Even with the restrictive covenant, Mrs. James could still get the home equity loan if Habitat for Humanity co-signed the loan. Why wouldn’t Habitat for Humanity help Mrs. James when they set her up for her financial problems by placing her in a home that was way more expensive than what she could ordinarily afford? The cynical answer is that Habitat for Humanity would prefer to lobby the local governments to reduce the taxes (and effectively subsidize Habitat for Humanity’s operations) than to help Mrs. James pay the taxes by herself.
Uncooperative game
The core of the problem illustrated in the Washington Post article is a sad uncooperative game being played by Habitat for Humanity and Mrs. James. It is a game that squanders the potential bonus of the rising real estate value of Mrs. James’ home. Habitat for Humanity wants to do what is impossible: produce affordable housing in Northern Virginia. It is impossible because demand for housing, even lousy housing, is so strong in this area that any home is very valuable, and therefore very unaffordable. Habitat for Humanity tries to fight the market by selling the home at well below market value. But if the owner were to simply resell the home, Habitat for Humanity would have produced no new affordable housing in the area. So Habitat for Humanity restricts the resale of the home so that the homeowner is forced to live in the “gift” house. Although the article did not mention it, I would guess that Habitat for Humanity restricts the owner from renting out the house because this would also defeat Habitat for Humanity’s purpose of producing affordable housing. So the net result of the restrictions is that a potentially valuable home is made much less valuable to the owner. But this destruction of value serves the purpose, ironically, of attracting labor to Habitat for Humanity’s enterprise because they can then point to all of the low-income housing that they have produced in the area. Habitat for Humanity participates in the production of the poverty of their homeowners because it doesn’t serve Habitat for Humanity interests to help these people get wealthy on these homes that they did very little to earn.
It isn’t entirely clear, however, why Habitat for Humanity would not want to co-sign a home equity loan for purpose of doing necessary repairs and for alleviating some of the burden caused by increasing taxes. They could be paternalistic and insist that the homeowner only borrow exactly what she needs. Habitat for Humanity could insist that the homeowner pay them a cut of the loan to help buy other properties to renovate. It could be that Habitat for Humanity volunteers would be turned off by the discovery that owners and Habitat for Humanity were making deals. People won’t volunteer their hard labor to make other people wealthy. But this should not mean that no deals at all are possible between Habitat for Humanity and the homeowners. After all, Mrs. James is not going to be wealthy because of a small home equity loan to pay for the leak in her living room and her $5000 tax bill. It is a sad example of how a charity can be oddly indifferent to the suffering that their rules have brought upon the very people they claim to want to aid.
Habitat for Humanity should reconsider their incentive compatibility issues. They want to make sure that the homeowners are “deserving.” But who deserves a below market home? Maybe the Habitat for Humanity volunteers do. Suppose Habitat for Humanity instituted a rule that these homes only go to volunteers who have worked with Habitat for Humanity for at least 2000 hours (up from a minimum of 300 hours). They would then be giving valuable human capital skills to the poor, increasing their labor force, and making sure the new owners deserved these homes. Then, there would be less ill will toward those who used a home equity loan against their “gift” home for bettering their lives.
posted by Michael Higgins at
20:38
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6 Comments:
it seems to me that a help up means dont get up to high if the market flops who has to pay the owner but if it goes up then well we wouldnt want to help to much. dont you think that if you take a poor family who has worked on the project for years you would be happy that it is a one family out of the poor house. the kid have a good life and on it goes not habitat being land barrens but the poor getting a break and isnt that why peope donate to give someone less fortunate ahand up rember it could be you and i know how quick the fall is so have a heart if it is really thier house they should benifite othwise dont lie to them saying you own a house when it is nothing like owning
By
Anonymous, at 4:41 AM
Nice analysis. Too often programns like HFH neglect to consider the market forces at work- how their money simply displaces other funds, or how they create problems like the one outlined.
Too often those with charitible impulses want to make changes at the far end of the causal chain- providing houses, for example- when it might be far more efficient and productive in the long run to help create employment. What if all that time and money spent building houses was instead used to create employers?
But judging from the critical responses to your blog, the people who support HFH don't think in economic terms. They prefer to do what's "morally right", and if the consequences aren't what they intended...
By
michael edelman, at 1:46 PM
In a free market, builders could and would build enough housing to make it affordable while profitable.
There is obviously a shortage of housing caused by government restrictions.
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