Pick the Right Goal | Eastern North Carolina Now

   Publisher's note: The article below appeared in John Hood's daily column in his publication, the Carolina Journal, which, because of Author / Publisher Hood, is inextricably linked to the John Locke Foundation.

    RALEIGH     For the better part of a century, U.S. politicians have made it one of their major goals to maximize the proportion of Americans who purchase rather than rent their primary dwellings. Federal and state policymakers have enacted dozens of laws and regulations to promote homeownership, including the income-tax deduction for mortgage interest, the creation of Fannie Mae and Freddie Mac, and government regulations compelling banks to make risky mortgage loans.

    But homeownership should never have been a policy goal in the first place. And as we now know, using the blunt tool of government taxes and regulations to promote it has distorted the investment market and subjected the broader economy to massive risk.

    It's important to distinguish between homeownership and asset ownership. The former is a subset of the latter. To remove the barriers that prevent Americans from accumulating assets over the course of their working lives is, indeed, a worthy public policy goal. It would have economic, social, and political benefits. I wrote about these benefits in my 2001 book Investor Politics.

    If politicians are going to smuggle the economic concept of investment into their political agenda, however, they have a responsibility to apply it properly. A key insight is that investors shouldn't put all their eggs in one basket - that they ought to diversify their portfolios. Different classes of assets tend to have different levels of volatility and payoff. At the same time that private investment counselors were urging their clients to maintain a diverse mix of assets, the nation's politicians were either encouraging or compelling their constituents to devote most of their annual savings to housing.

    As University of Wisconsin economist Morris Davis explained in a recent paper for the Cato Institute, these "public investment counselors" were offering spectacularly bad advice.

    While homeownership can often be a rational choice for households to make, it has risks. Prices don't always rise. And residential real estate is a less liquid asset than, say, stocks and bonds. At the time you may want to sell, there may be few buyers. If it is your primary dwelling, you not only own the asset but also use it every day. This can make it tricky or costly to arrange the cascade of transactions required to transfer ownership, as anyone who has moved from one house to another can attest.

    Rather than choose real estate for preferential treatment, politicians should have fashioned policies that reduced government's bias against investment of all kinds. Here are the main elements of such a reform agenda:

    • Reform the tax code to alleviate the multiple, punitive layers of taxation on dividends, interest, or capital gains. That would mean taxing either the principle of an investment, or its return, but not both. In effect, such a system would tax income at the time it is consumed, regardless of whether that time is tomorrow or 10 years from now. For financial assets, unlimited access to tax-deferred IRAs or 401ks would suffice. For physical capital such as real estate or artwork, the best application of the idea would be to tax the money used to buy the asset, both principal and interest payments, but then exempt its subsequent sale from capital-gains tax. For human capital such as education and training, both firms and households ought to be able to deduct a portion of their annual spending on this valuable form of investment.

    • Reform Social Security, Medicare, and other entitlements to include individually owned accounts as well as a minimum safety net for retired or disabled beneficiaries. Essentially, current entitlement programs force taxpayers to "contribute" large chunks of their annual income into a system that appears to save up their money for future use. These programs doesn't really do this, but the appearance is politically attractive. Let's turn that appearance into a reality.

    If you choose the wrong goal, you are setting yourself up for failure. With the Great Recession serving as a reminder of how painful such a failure can be, now is the time to choose the right goal.