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Is the Tax Cut the Root Cause of the Crisis?

One daily discusses its effects.

Th New York Times recently ran a comprehensive take on the Taxpayer Relief Act of 1997. The infamous law became an issue as some analysts attribute the main cause of the current crisis to former President Bill Clinton’s plan. It exempted home sellers from paying the capital gains tax of up to $500,000 for married couples and $250,000 for singles. The report cites some interesting observations:

• The law gave people a motive to buy more and more real estate. Lax lending standards and low interest rates then gave people the means to do so. By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than as a place to live. It helped change the national conversation about housing.
• The tax forced homeowners to keep track of all their renovations over many years, because the cost of those renovations could be subtracted from their taxable gain.
• People could also avoid the tax under a one-time exemption for profits of up to $125,000 if they were older than 55. Thus, the tax raised relatively little revenue — perhaps just a few hundred million dollars in today’s terms.
• Before 1997, people had to buy a house that was at least as valuable as their previous one to avoid the tax, or else take the one-time exemption. Now they could buy a smaller property or move into a rental.

These reasons may be convincing but following the papers for these past months have led us to assume that the public perceives the crisis to be a chicken and egg problem. The authors, Vikas Bajaj and David Leonhardt, aptly put their unbiased opinion by stating that there are other reasons as to why the crisis has grown to such enormity to the point of crippling the entire economy. With this, we agree that the law may have contributed to the glut of home supply but several factors may also be considered sources of the crisis including:

1.) Unabated subprime mortgage lending – this has nothing to do with the Tax Payer Relief Act, however the mortgage lenders acted on their impulse either to gain more profit or follow their CEO’s orders to reach their quota.

2.) Weak oversight in the lending markets – the government has relaxed much of its regulatory authority to counteract the hardship in mortgage selling. Ben Bernanke knows about this before the beginning of the recession last December 2007.

3.) Overconfidence on the part of the government on the stability of the housing market – there was too much belief that prices will remain in its housing boom, until we all learned that the housing cycle can turn immediately before we know it.

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