Thursday, October 12, 2006

 

Selective Application of Market Principles

One of my Libertarian-Conservative friends argues that our society would be better off if government would simply let market forces apply to some of our serious problems. For example, rather than try to create an expensive bureaucracy to tackle the problem of insufficient access to health care, government should simply get out of the way and let the free market solve the problem. Consumers of health care would then choose the least expensive and most effective service providers and insurers. Service providers who charge too much for their services would lose out to the more effective and less expensive providers. Private charitable organizations would take care of the very poor; those who can’t afford even the cost of minimum health care. It may sound cruel to say it, but persons with medical conditions that require extremely expensive treatments would be allowed to die. In that way, the rest of society would not be burdened with the cost of their treatments.

Another example is the existence of a growing class of retired workers who enjoy defined benefit pensions. These pensions are paid by taxing workers who haven’t yet retired. Because of advances in medical care and a declining birth rate, the ratio of retired pensioners to tax-paying workers is increasing. Eventually the tax burden on the workers will become politically impossible to maintain. The best thing to do about the problem, my L-C friends say, is to replace the tax-based defined benefit pension with a personal retirement account for each worker. The tax code should be adjusted to encourage a worker to put aside a portion of his earnings in a tax-free savings account. The money in the account would not be available until the worker retires or unless the worker experiences a medical emergency.

I’m sure you have heard these arguments. You probably agree with me that they are impractical and heartless, unworthy of our affluent and generous society.

One argument that I have not heard is to let market forces deal with the current real estate bubble in California. My house is a typical example. My wife and I bought our present house in 1968 at a price of $39,000. A few years later the housing boom was in full swing and the house was assessed at $50,000. The property tax had risen from about $800 a year to $1,000. The voters enacted the California property tax limitation law, Proposition 13, which froze the assessment at its value in the year 1975. If I sold my house the new owner would have an assessment based on the market price of the house at the time of the sale, but that assessment would also be frozen. Frozen assessments would be allowed to increase at a rate of no more than two percent a year.

My house is now worth something between $500,000 and $800,000. My property tax is only $1500 per year. That tax implies a frozen assessment of $75,000, approximately one-tenth of the market value of the house at last year’s prices. My situation is like that of many Californians who were fortunate enough to buy a house years ago when they were affordable. Persons in my situation who already own a house have another advantage provided by government. I can sell my house and buy another house in the same county and keep my Proposition 13 assessment. I am completely insulated from the economic consequences of the housing bubble.

A new buyer who buys my house would need to take out a mortgage for most of the sale price. Suppose I sell the house for $600,000. The new buyer has to pay, say, ten percent of the sale price and take out a mortgage for the remaining ninety percent. That is, he would have a mortgage of $540,000 to pay off in thirty or forty years. A rule of thumb is that the monthly mortgage payment is about one percent of the mortgage. This new buyer would have a monthly payment in excess of $5000. The annual taxes would be about $12,000 or an additional $1,000 a month. There is an old rule that the cost of housing should not exceed one-third of your income. The person who buys my house should have an income of more than $200,000 a year.

Proposition 13 was an example of government intervention in the housing market. If Proposition 13 did not exist, property taxes would have increased along with the market price of houses. Many people at or near retirement would have realized that they could not afford the taxes on their houses after retiring and would have sold them and moved to less expensive accommodations. Many more houses would be on the market. The effect would have been to keep prices much lower than they were. Libertarian and conservative enthusiasts would, or should, argue that the present housing bubble is partly a consequence of government interference with the operation of free markets; i.e., Proposition 13 is partly to blame for the housing bubble.

Am I crazy? Why is it left to me, a crypto-socialist, to make the libertarian argument against Proposition 13?
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