QuoteDavid Frum: Saving the U.S. economy — the Canadian way
Posted: December 05, 2009, 9:30 AM by NP Editor
David Frum
Barack Obama this week convened a jobs summit to discuss the awful U.S. unemployment numbers. Should the federal government hire unemployed workers directly? Pay money to states so that they can hire people?
If I'd been invited, here's what I would have advised: Learn from Canada.
America's situation today resembles Canada's in 1992-93: a horrific recession, terrifying indebtedness, and gathering doubts about the country's future.
Fifteen years ago, Canadian authorities made one crucial decision: They allowed the currency to depreciate. The Canadian dollar dwindled to as little as U.S. ¢62.
It was as if all of Canada had been put on clearance sale. Every asset within Canada was devalued, every wage was cut. Median hourly wages in wealthy Ontario tumbled below wages in Mississippi. Canadian purchasing power was slashed. Canadians suddenly had to pay more for almost every internationally traded good and service, from orange juice to software programs to foreign holidays.
Canadians were compelled to consume less. By discounting Canadian assets, they sold more. And because their labor suddenly cost less, they were employed more.
Nobody enjoyed this policy. The policy's inherent pain was aggravated by the Chrétien government's simultaneous decision to maintain taxes at very high levels — the government rescued its own finances first, and left Canadians' personal finances for second.
Whatever one thinks of the Chrétien government's tax policies, however, the currency policy did its job. Exports jumped, the Canadian growth rate accelerated, and Canadian living standards recovered.
Meanwhile, the Americans were conducting a very different kind of economic policy — a policy that emphasized debt and consumption rather than work and export.
The United States may run the most pro-borrowing public policy on Earth. An American home mortgage is tax deductible, as Canadians know. Americans use this subsidy from the government to buy more house for their money: On the eve of the recession, the average new home in the United States contained more than 2,300 square feet of space, as compared to about 1,850 square feet for the average new Canadian home.
Two other pro-borrower policies may matter even more than home deductibility. An American mortgage is almost always non-recourse. If a home owner does not pay his or mortgage, the lender can repossess — but cannot usually reach the home-owner's other assets. The home-owner may have a million dollars in the very same bank that holds the mortgage, but the bank account is as unreachable as if it were located in the Cayman Islands.
Non-recourse loans create a one-way option for borrowers. They borrow to buy an asset they expect to increase in value. If the borrower guesses right, he or she gains a windfall. If wrong, he or she walks away, leaving the loss to the lender.
It gets better! Suppose a buyer accepts a fixed-rate mortgage at 5% and mortgage rates rise to 6%. Too bad for the lender: The rate is fixed, the buyer is protected.
Suppose, however, that mortgage rates decline to 4%. The lender is not protected. The buyer has the right to pay off his high-rate loan, usually without penalty, and refinance at the lower rate.
One more thing. Capital gains on the sale of a principal residence are untaxed, so long as the buyer reinvests in another residential property.
Altogether, the incentives combine to invite borrowing, speculation, and property flipping. Supercharge those incentives with no-down-payment, no-paperwork mortgages — and a crisis is made.
Step two after a Canadian-style currency depreciation should be a shift to a Canadian-style approach to home finance. The first shift will encourage work; the second shift will encourage saving.
Unfortunately, the ideas President Obama seems eager to import from Canada are not these right lessons, but instead two wrong lessons: the need for higher taxes and more government control of the health care system.
It's as your children's teachers tell you: You can only teach those who want to learn.
http://network.nationalpost.com/np/blogs/fullcomment/archive/2009/12/05/david-frum-saving-the-u-s-economy-the-canadian-way.aspx
:Canuck:
Government control of the health care system is the wrong lesson? I guess I shouldn't be surprised by this from Frum, but it's still pretty dumb.
I am confused about some things.
First of all, in Canada, can banks cancel mortgages at will? The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this). The other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).
Secondly, in Canada, are fixed-rate mortgages illegal? the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.
I am rather astonished that someone would share such a shoddy article with us. It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! :lol:
I guess the depreciation of the US dollar has not been deliberate enough for the author, but it is unclear to me exactly how he wants the US to sabotage its dollar. Looking at the US-Canadian dollar exchange rate, the massive drop he claims happened 15 years ago is not apparent; the $C didn't hit US$0.62 until 2002, and that (my math tells me) is much more recent than 1992. The decline of the $US in 2007 had none of the miraculous effects that Frum said it would. :(
I am calling shenanigans.
Quote from: Jacob on December 11, 2009, 06:12:11 PM
Government control of the health care system is the wrong lesson? I guess I shouldn't be surprised by this from Frum, but it's still pretty dumb.
He's a God out in the South Pacific.
I wonder what Frum means when he says Canada "allowed" the currency to depreciate. AFAIK the looney has been floating ever since the end of Bretton Woods. Did Canada stop selling reserves to prop up the value?
I also don't see the connection between the exchange rate and real estate markets.
Quote from: grumbler on December 11, 2009, 06:29:45 PM
I am confused about some things.
First of all, in Canada, can banks cancel mortgages at will? The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this). The other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).
Secondly, in Canada, are fixed-rate mortgages illegal? the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.
I am rather astonished that someone would share such a shoddy article with us. It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! :lol:
I guess the depreciation of the US dollar has not been deliberate enough for the author, but it is unclear to me exactly how he wants the US to sabotage its dollar. Looking at the US-Canadian dollar exchange rate, the massive drop he claims happened 15 years ago is not apparent; the $C didn't hit US$0.62 until 2002, and that (my math tells me) is much more recent than 1992. The decline of the $US in 2007 had none of the miraculous effects that Frum said it would. :(
I am calling shenanigans.
Yeah, I'm thinking that's the right call.
As for mortgages, here's how it works up here (AFAIK) compared to what I'm
guessing is the way it is in the US (making no claims here, so feel free to point out where I'm wrong):
Mortgage payments are not tax-deductible.
If I get a fixed rate mortgage, which I usually do, I can refinance before the term is up to take advantage of lower interest rates but I may well pay a penalty for doing so as that's written into the terms of the mortgage. There's usually a limit to how much you can pre-pay and you cannot pay more than that. I believe it's commonly something like 15-25% of the original principal per year plus maybe double monthly payments. In most cases you can't just show up with half a million cash and pay off your balance if you have it, unless you pay some penalties too.
I don't believe houses are protected in general bankruptcies, nor do I believe that I can go bust on my mortgage without my other assets being on the line.
QuoteCanadians suddenly had to pay more for almost every internationally traded good and service, from orange juice to software programs to foreign holidays.
Canadians were compelled to consume less. By discounting Canadian assets, they sold more. And because their labor suddenly cost less, they were employed more.
[...] however, the currency policy did its job. Exports jumped, the Canadian growth rate accelerated, and Canadian living standards recovered.
Unlike Canada, the US is using the currency that virtually all international trade is denominated in anyway. Depreciating the dollar will only cause a recession in the countries that let their currency float against the dollar, whereas it doesn't solve the real imbalance, namely the massively undervalued renminbi. Causing a recession in those countries means that there is no one to buy more US exports, so what the policy will do is lessening US imports, but not increasing US exports much. That will close the trade gap a bit, but at the price of less wealth for everyone involved.
So why doesn't Obama just ban all Chinese goods until they adjust their currency, and confiscate all property owned by Chinese-owned businesses? Problem solved.
Quote from: Neil on December 11, 2009, 08:14:54 PM
So why doesn't Obama just ban all Chinese goods until they adjust their currency, and confiscate all property owned by Chinese-owned businesses? Problem solved.
Against the law, for starters.
Quote from: Admiral Yi on December 11, 2009, 08:16:36 PM
Quote from: Neil on December 11, 2009, 08:14:54 PM
So why doesn't Obama just ban all Chinese goods until they adjust their currency, and confiscate all property owned by Chinese-owned businesses? Problem solved.
Against the law, for starters.
Why would that stop him? I seem to recall another president during tough economic times who didn't care about the law. He was also a raving egomaniac with excellent PR skills.
Quote from: grumbler on December 11, 2009, 06:29:45 PM
I am confused about some things.
First of all, in Canada, can banks cancel mortgages at will? The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this). The other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).
Secondly, in Canada, are fixed-rate mortgages illegal? the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.
I am rather astonished that someone would share such a shoddy article with us. It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! :lol:
I guess the depreciation of the US dollar has not been deliberate enough for the author, but it is unclear to me exactly how he wants the US to sabotage its dollar. Looking at the US-Canadian dollar exchange rate, the massive drop he claims happened 15 years ago is not apparent; the $C didn't hit US$0.62 until 2002, and that (my math tells me) is much more recent than 1992. The decline of the $US in 2007 had none of the miraculous effects that Frum said it would. :(
I am calling shenanigans.
ya. Hilarious that Frum is pushing for Chretien like policies. also.
actually the CAD dropped to similarly low (but not quite 62 cents) in the late 90s as the link below shows. the late 90's was just as crappy jobs wise as the early 90's. maybe worse.
http://www.cbc.ca/news/interactives/map-history-dollar/ (http://www.cbc.ca/news/interactives/map-history-dollar/)
Devaluing the currency doesn't work well when your currency is also the world's currency.
I favor screwing the entire world over as we go down in flames.
This is pretty silly, for reasons already pointed out. The US can't really control its exchange rate, and the dollar occupies a fundamentally different position in international finance than the loonie. With respect to the critical bilateral relationship with China, it should be obvious that the US can't simply devalue the dollar. The article also ignores other relevant fundamentals driving the Canadian economy, such as the commodities super-cycle.
The dollar has been getting its ass kicked recently anyway.
Quote from: alfred russel on December 12, 2009, 05:34:06 PM
The dollar has been getting its ass kicked recently anyway.
Frum must have some serious pull.
Quote from: Admiral Yi on December 11, 2009, 06:48:04 PM
I wonder what Frum means when he says Canada "allowed" the currency to depreciate.
Through the 80s Canada had a pretty aggressive policy of keeping interests high to make the currency more attractive. It was a very contraversial policy as many argued keeping interest rates artificially high to protect the currency did more harm then good. The shift away from that policy is what Frum is talking about.
I have no idea what he is going on about in the rest of the article. Canada has many of the same mortgage features he is complaining about. The only ones that stand out as being different are that in the US mortgages are tax deductable (which does tend to encourage people to take on more debt) and the other is his description of US non recourse loans although from previous discussions I seem to recall rules vary among States on that.
I am also proud to say that I have brought up the average square footage of Canadian dwellings.
Quote from: crazy canuck on December 12, 2009, 05:45:15 PM
Through the 80s Canada had a pretty aggressive policy of keeping interests high to make the currency more attractive.
OK, that makes sense. Thanks. Though obviously not an option for the US right now.
Quote from: Admiral Yi on December 12, 2009, 05:48:18 PM
OK, that makes sense. Thanks. Though obviously not an option for the US right now.
No, I agree. In fact I have no idea why he thinks that anything Canada does appropriate in the US. Your economy and currency are completely different.
I used to think Frum had some interesting things to say. This piece is just silly.
There are reasons that mortgage interest should be deductible.
Everyone has to live in a home: either as a renter or a homeowner. If you are a renter, the owner can deduct the interest as a business expense--just like any other business related interest. If a homebuyer can't deduct the interest, the financing costs are going to be greater on an after tax basis, everything else being equal. In effect there is an incentive for people to rent homes versus purchase them.
Quote from: alfred russel on December 12, 2009, 05:55:33 PM
There are reasons that mortgage interest should be deductible.
Everyone has to live in a home: either as a renter or a homeowner. If you are a renter, the owner can deduct the interest as a business expense--just like any other business related interest. If a homebuyer can't deduct the interest, the financing costs are going to be greater on an after tax basis, everything else being equal. In effect there is an incentive for people to rent homes versus purchase them.
Fine. That policy reflects the social policy emphasis in the US to encourage everyone to own their home. We are more conservative in that we prefer not to encourage debt as a general rule. Generally speaking you are a nation of risk taker while we are a nation of curlers.
Quote from: crazy canuck on December 12, 2009, 05:59:01 PM
Quote from: alfred russel on December 12, 2009, 05:55:33 PM
There are reasons that mortgage interest should be deductible.
Everyone has to live in a home: either as a renter or a homeowner. If you are a renter, the owner can deduct the interest as a business expense--just like any other business related interest. If a homebuyer can't deduct the interest, the financing costs are going to be greater on an after tax basis, everything else being equal. In effect there is an incentive for people to rent homes versus purchase them.
Fine. That policy reflects the social policy emphasis in the US to encourage everyone to own their home. We are more conservative in that we prefer not to encourage debt as a general rule. Generally speaking you are a nation of risk taker while we are a nation of curlers.
I'm not a huge proponent of the deductibility of mortgage interest--there are arguments for and against. But what I posted previously doesn't reflect a rationale of encouraging home ownership in the US, it reflects that Canada is actually discouraging it through its tax policy while the US is seeking to stay neutral.
This is the first time I have heard someone claim mortgage deductability was not a policy to encourage home ownership.
Quote from: crazy canuck on December 12, 2009, 06:08:40 PM
This is the first time I have heard someone claim mortgage deductability was not a policy to encourage home ownership.
It is. But at the same time ordinary tax law discourages home ownership.
Fredo, I thought your point was going to be that either the rental property developer or the homeowner is going to be doing the borrowing, so from a total national indebtedness POV it doesn't make a differerence.
Quote from: alfred russel on December 12, 2009, 05:34:06 PM
The dollar has been getting its ass kicked recently anyway.
Only as much as was the norm prior to the recession. In terms of dollar strength a collapsing global economy really seemed to help :mellow:
Quote from: crazy canuck on December 12, 2009, 05:59:01 PM
Fine. That policy reflects the social policy emphasis in the US to encourage everyone to own their home. We are more conservative in that we prefer not to encourage debt as a general rule. Generally speaking you are a nation of risk taker while we are a nation of curlers.
The point Alfred (and Yi) are making is an interesting one, actually. Canadian policy on the face of it seems less to discourage owning homes, as it is to discourage anyone to own homes except as a business of owning homes. Business interest is an expense and so deductible, no?
I am not saying that this is how it works in practice, mind; I don't know that. I am just pointing out an interesting consequence of their argument taken by itself.
Quote from: Admiral Yi on December 12, 2009, 06:31:15 PM
Fredo, I thought your point was going to be that either the rental property developer or the homeowner is going to be doing the borrowing, so from a total national indebtedness POV it doesn't make a differerence.
I really just wanted to make a point regarding home mortgage interest deductibility.
Quote from: grumbler on December 12, 2009, 07:00:44 PM
The point Alfred (and Yi) are making is an interesting one, actually. Canadian policy on the face of it seems less to discourage owning homes, as it is to discourage anyone to own homes except as a business of owning homes. Business interest is an expense and so deductible, no?
I am not saying that this is how it works in practice, mind; I don't know that. I am just pointing out an interesting consequence of their argument taken by itself.
Its not an either or situation as Yi suggests. Mortgage deductability encourages people to take larger loans and then encourages people to not pay off those debts.
Both those things have impacts on the economy. Encouraging people to take larger loans then they otherwise would also encourages home builders to build more expensive homes then they might otherwise build. I think this is the point Frum was trying to make when he was comparing average square footage of households in the US and Canada - although admittedly the fact that your society is on average more wealthy then ours is more of a cause of that difference then this tax policy.
If American consumers have more exposure to home debt and they keep that debt then if things go bad (incomes drop or interest rates rise) then banks start to fail and consumer spending goes down. One thing I do think the Americans can learn from us is how we regulate our banking system in relation to residential mortgages. No Canadian banks failed and in fact turned in large profits while American banks were being fed billions by the US government.
If there was not mortgage deductability then home builders would build smaller less expensive homes, on average because the average consumer could afford less and would want to pay off that debt sooner.
Quote from: crazy canuck on December 14, 2009, 12:26:05 PM
Quote from: grumbler on December 12, 2009, 07:00:44 PM
The point Alfred (and Yi) are making is an interesting one, actually. Canadian policy on the face of it seems less to discourage owning homes, as it is to discourage anyone to own homes except as a business of owning homes. Business interest is an expense and so deductible, no?
I am not saying that this is how it works in practice, mind; I don't know that. I am just pointing out an interesting consequence of their argument taken by itself.
Its not an either or situation as Yi suggests. Mortgage deductability encourages people to take larger loans and then encourages people to not pay off those debts.
Both those things have impacts on the economy. Encouraging people to take larger loans then they otherwise would also encourages home builders to build more expensive homes then they might otherwise build. I think this is the point Frum was trying to make when he was comparing average square footage of households in the US and Canada - although admittedly the fact that your society is on average more wealthy then ours is more of a cause of that difference then this tax policy.
If American consumers have more exposure to home debt and they keep that debt then if things go bad (incomes drop or interest rates rise) then banks start to fail and consumer spending goes down. One thing I do think the Americans can learn from us is how we regulate our banking system in relation to residential mortgages. No Canadian banks failed and in fact turned in large profits while American banks were being fed billions by the US government.
If there was not mortgage deductability then home builders would build smaller less expensive homes, on average because the average consumer could afford less and would want to pay off that debt sooner.
That's mostly my read of it as well.
Having mortgage interest as deductable means that it makes sense to - get a bigger mortgage and/or not pay it off as quickly. It also changes the dynamic of choice between owning & renting, if money paid in rent is not deductable.
It's important to keep seperate the effects of the mortgage interest deduction and the recent subprime bubble. As long as proper credit controls are in place I don't see how the deduction increases inherent credit riskiness.
Quote from: Admiral Yi on December 14, 2009, 01:48:43 PM
It's important to keep seperate the effects of the mortgage interest deduction and the recent subprime bubble. As long as proper credit controls are in place I don't see how the deduction increases inherent credit riskiness.
In that it encourages people to take out more debt and to amortize it over a longer period than they would otherwise. More debt over a longer period = more risk from market fluctuations.
Quote from: Malthus on December 14, 2009, 01:54:10 PM
In that it encourages people to take out more debt and to amortize it over a longer period than they would otherwise. More debt over a longer period = more risk from market fluctuations.
More risk to who, the lender? Interest rate risk is compensated by the positive yield curve. Longer term instruments pay higher interest.
Quote from: Admiral Yi on December 14, 2009, 02:02:47 PM
Quote from: Malthus on December 14, 2009, 01:54:10 PM
In that it encourages people to take out more debt and to amortize it over a longer period than they would otherwise. More debt over a longer period = more risk from market fluctuations.
More risk to who, the lender? Interest rate risk is compensated by the positive yield curve. Longer term instruments pay higher interest.
More risk of default, if economic conditions turn bad.
I am no longer as certain as I was that banks are necessarily good judges of the correct risk-reward ratio over the long term.
Quote from: Admiral Yi on December 14, 2009, 02:02:47 PM
Quote from: Malthus on December 14, 2009, 01:54:10 PM
In that it encourages people to take out more debt and to amortize it over a longer period than they would otherwise. More debt over a longer period = more risk from market fluctuations.
More risk to who, the lender? Interest rate risk is compensated by the positive yield curve. Longer term instruments pay higher interest.
More risk to everyone. More risk to lenders because they have not been able to judge risk appropriately, certainly more risk to borrowers and more risk to the general health of your economy.
Are commercial real estate loans typically shorter maturity? You guys may be right, need to think about it.
Although Malthus' point about banks' ability to assess risk doesn't really touch on the mortgage interest deduction.
Quote from: Malthus on December 14, 2009, 12:33:13 PM
It also changes the dynamic of choice between owning & renting, if money paid in rent is not deductable.
You are ignoring my posts. What screws up that dynamic is the Canadian system, where renters can deduct their interest charges (which are at least partially passed on to rentors in a competitive market) but buyers can not.
Quote from: Admiral Yi on December 14, 2009, 02:13:59 PM
Are commercial real estate loans typically shorter maturity?
Yes. And they tend to be at higher interest rates.
But business loans in general tend to be shorter term, with the expectation of rolling the loan over versus paying it off. It isn't an apples to apples comparison.
People who rent cannot be trusted and vote Socialist.
Quote from: crazy canuck on December 14, 2009, 02:10:21 PM
More risk to everyone. More risk to lenders because they have not been able to judge risk appropriately, certainly more risk to borrowers and more risk to the general health of your economy.
Then why not protect the health of the economy by not allowing any interest to be deductible? From your line of thinking that would reduce risks to the health of your economy.
Quote from: alfred russel on December 14, 2009, 02:23:29 PM
Quote from: Admiral Yi on December 14, 2009, 02:13:59 PM
Are commercial real estate loans typically shorter maturity?
Yes. And they tend to be at higher interest rates.
But business loans in general tend to be shorter term, with the expectation of rolling the loan over versus paying it off. It isn't an apples to apples comparison.
No, commercial real estate loans are short duration because the bank anticipates that it will get its money (and the developer will make a profit) after the units are sold. No bank, at least in Canada, would loan to a developer on a never never plan or rolling loans. Maybe that is another aspect of the difference in lending practices between our countries.
edit: There was one notable developer the banks did do that for but when it went tits up in the about two decades ago the banks learned their lesson and didnt do that again.
Quote from: alfred russel on December 14, 2009, 02:28:15 PM
Quote from: crazy canuck on December 14, 2009, 02:10:21 PM
More risk to everyone. More risk to lenders because they have not been able to judge risk appropriately, certainly more risk to borrowers and more risk to the general health of your economy.
Then why not protect the health of the economy by not allowing any interest to be deductible? From your line of thinking that would reduce risks to the health of your economy.
To many double negatives in there. I think you are actually agreeing with me that mortgage deductability is a bad idea.
Sorry, should have said rental property developer loan instead of commercial property loan.
Quote from: The Brain on December 14, 2009, 02:23:40 PM
People who rent cannot be trusted and vote Socialist.
Its funny because the reason often stated for US policies to encourage home ownership was the fear of a non land owning population moving toward socialism.
Quote from: Admiral Yi on December 14, 2009, 02:31:38 PM
Sorry, should have said rental property developer loan instead of commercial property loan.
Ok, I am not sure about the answer to that. Rental property development has not been profitable for years so I am not sure that anyone actually does it anymore.
The typical rental model in large Canadian cities is that a developer will build muti-dwelling units and sell them to the public. Some of those who buy will purchase the units as an investment and rent them while they wait for the market to increase so they can then sell and make their profit.
A recent requirement of developers is that they also build something called "low cost housing" as part of their developments. Those are units that are specifically built for renters at regulated prices but they are not financed separately. It just reduces the profitability of the over all project.
Quote from: crazy canuck on December 14, 2009, 02:30:22 PM
To many double negatives in there. I think you are actually agreeing with me that mortgage deductability is a bad idea.
I'm not--it seems from your post that we could protect our economy from risk by removing all interest deductibility.
Quote from: alfred russel on December 14, 2009, 02:37:02 PM
Quote from: crazy canuck on December 14, 2009, 02:30:22 PM
To many double negatives in there. I think you are actually agreeing with me that mortgage deductability is a bad idea.
I'm not--it seems from your post that we could protect our economy from risk by removing all interest deductibility.
Thats an overstatement. You cant protect your economy from risk but you can reduce the risk of artificially encouraging people to take on more debt then they otherwise would.
Quote from: crazy canuck on December 14, 2009, 02:39:38 PM
Thats an overstatement. You cant protect your economy from risk but you can reduce the risk of artificially encouraging people to take on more debt then they otherwise would.
But what is "artificial?" Businesses wouldn't take on so much debt if they didn't get a deduction for the interest.
Why should investment related real estate, almost always financed through debt, get a deduction while a homeowner doesn't?
Quote from: alfred russel on December 14, 2009, 02:21:06 PM
Quote from: Malthus on December 14, 2009, 12:33:13 PM
It also changes the dynamic of choice between owning & renting, if money paid in rent is not deductable.
You are ignoring my posts. What screws up that dynamic is the Canadian system, where renters can deduct their interest charges (which are at least partially passed on to rentors in a competitive market) but buyers can not.
Renters getting a deduction isn't the same thing at all as the people who rent getting a deduction.
The rules here seem to be that if you borrow to make money as a business, you get a deduction; if you borrow to buy a non-business asset like a house to live in, you do not.
Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.
According to wikipedia:
QuoteThe home ownership rate in Canada is about the same as in the United States,[2] but Canadians have about 70%[3] equity in their homes on average (i.e., 30% mortgage debt), compared to only 45% average home equity in the United States.
Quote from: alfred russel on December 14, 2009, 02:44:05 PM
Quote from: crazy canuck on December 14, 2009, 02:39:38 PM
Thats an overstatement. You cant protect your economy from risk but you can reduce the risk of artificially encouraging people to take on more debt then they otherwise would.
But what is "artificial?" Businesses wouldn't take on so much debt if they didn't get a deduction for the interest.
Why should investment related real estate, almost always financed through debt, get a deduction while a homeowner doesn't?
Here's the standard argument as to why profit-earning businesses should get the deduction while consumption such as housing should not:
http://www.taxfoundation.org/blog/show/1081.html
QuoteDespite the political popularity of the tax deduction for home mortgage interest, economists are basically united in their opposition to it.
What's the economic case against it? Simple: by giving a tax subsidy to housing, it distorts investment decisions toward houses and away from assets like factories and equipment that are more productive at the margin. And that makes workers less productive, ultimately lowering wages and making society poorer.
A recent GAO primer on tax reform makes a clear and persuasive case against the mortgage interest deduction:
Tax Treatment of Owner-Occupied Housing Distorts Investment Choices and Lowers Wages
Compared to other types of investment, owner-occupied housing enjoys tax advantages primarily because the value that homeowners receive from housing services, which is a part of the return on their investment in housing, is excluded from taxation. Economists view these services, called imputed rent, as income in kind, which is valued at what the homeowner would receive as income if the house was rented.
Under a pure income tax, imputed rent net of such costs as mortgage interest would be taxed. This tax treatment would help insure that investment in housing is taxed as other investments are taxed. As the table below shows, the tax advantages under the current system lead to lower marginal effective tax rates (METR) for housing relative to other investments.
Marginal Effective Tax Rates on Capital, by Source, 2003 Owner-occupied housing: 2%
Noncorporate investment: 18%
Corporate investment: 32%
Source: Jane Gravelle, "The Corporate Tax: Where Has It Been and Where Is It Going?" National Tax Journal, vol. 57, no. 4 (2004): 903-23
Economists generally agree that the favorable treatment of owner-occupied housing, by lowering METR, distorts investment in the economy, resulting in too much investment in housing and too little business investment. The consequence of this is that businesses invest less in productivity-enhancing technology. This in turn results in employees receiving lower wages because increases in employee wages are generally tied to increases in productivity.
The resulting distortions from the tax-preferred treatment of owner-occupied housing lead to efficiency costs that have been estimated to be large. Gravelle's summary of estimates reports that the efficiency costs of the tax-preferred treatment of owner-occupied housing could be as much as 0.1 to 1 percent of GDP.
That's from a text box on page 39. Let's hope Members of Congress—who may be taking on federal tax reform next year—are actually reading these excellent GAO reports. Read the full report here (PDF).
Quote from: alfred russel on December 14, 2009, 02:44:05 PM
Why should investment related real estate, almost always financed through debt, get a deduction while a homeowner doesn't?
I dont understand the argument that business debt is the same as personal debt. They are fundamentally different, have different risks, different terms and have different impacts. In Canada they are treated differently and, as already mentioned, our banks didnt fail.
edit: just read what Malthus posted.
Quote from: Malthus on December 14, 2009, 02:59:58 PM
Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.
Not a good analogy. The consumer is not faced with a choice of buying vs. not buying jewelry, he's faced with the choice of buying vs. renting.
Quote from: Admiral Yi on December 14, 2009, 03:08:28 PM
Not a good analogy. The consumer is not faced with a choice of buying vs. not buying jewelry, he's faced with the choice of buying vs. renting.
I disagree, the choice is to take on debt or not.
Quote from: Admiral Yi on December 14, 2009, 03:08:28 PM
Quote from: Malthus on December 14, 2009, 02:59:58 PM
Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.
Not a good analogy. The consumer is not faced with a choice of buying vs. not buying jewelry, he's faced with the choice of buying vs. renting.
The issue is whether the business getting a deduction or the person getting a deduction for borrowing on the exact same asset is really similar or not.
Quote from: crazy canuck on December 14, 2009, 03:07:49 PM
In Canada they are treated differently and, as already mentioned, our banks didnt fail.
Which is explained better by Canada's regulation of the type of mortgages that can be offered, not the interest deduction.
Quote from: Malthus on December 14, 2009, 02:59:58 PM
Renters getting a deduction isn't the same thing at all as the people who rent getting a deduction.
The rules here seem to be that if you borrow to make money as a business, you get a deduction; if you borrow to buy a non-business asset like a house to live in, you do not.
Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.
The general rule is that interest related to business expenses is deductible, and interest related to personal expenses is not. The effect of this rule is a homeowner can not deduct interest expenses, while an investor renting out the property can.
A home interest deduction can negate the imbalance in the rent versus buy decision created by the tax law, it really doesn't create a new one.
I disagree that you can generalize that one type of debt is more prudent than another. My understanding is that in fact default rates are higher on investment properties than for homeownership, for example.
Quote from: Admiral Yi on December 14, 2009, 03:14:56 PM
Quote from: crazy canuck on December 14, 2009, 03:07:49 PM
In Canada they are treated differently and, as already mentioned, our banks didnt fail.
Which is explained better by Canada's regulation of the type of mortgages that can be offered, not the interest deduction.
Its all part of the same thing. Canada's regulation policy is all based on restricting the amount of debt a home owner can take on. US policy encourages more debt.
Quote from: alfred russel on December 14, 2009, 03:15:39 PM
My understanding is that in fact default rates are higher on investment properties than for homeownership, for example.
Which is why, in Canada anyway, the amount of equity a person investing in a property with the intent of renting must maintain a higher equity ratio then someone who is owning.
Again, getting back to the basic pricinciple that debt, in the housing market, should not be encouraged.
The odd thing is that while home ownership rates are about the same in the two countries, rates of debt to equity are much higher in the US.
Put this together with the alleged fact mentioned upthread that homes in the US tend to be larger and more expensive, it appears that what US policies encourage is not rate of home ownership per se, but rather ownership of more expensive homes.
Quote from: Malthus on December 14, 2009, 03:13:05 PM
The issue is whether the business getting a deduction or the person getting a deduction for borrowing on the exact same asset is really similar or not.
The business assumes debt to generate a revenue stream. The individual assumes debt to eliminate a cost stream. There may be others factors but that part seems symetrical.
Quote from: crazy canuck on December 14, 2009, 03:17:54 PM
Its all part of the same thing. Canada's regulation policy is all based on restricting the amount of debt a home owner can take on. US policy encourages more debt.
Holding all other factors constant, the interest deduction should result in similar debt to *after tax* income ratios.
Quote from: Malthus on December 14, 2009, 03:07:04 PM
Here's the standard argument as to why profit-earning businesses should get the deduction while consumption such as housing should not:
http://www.taxfoundation.org/blog/show/1081.html
I disagree with their point of view.
This isn't especially complicated. Imagine that you want to buy a $1,000,000 home with nothing down. 5% interest rate. There is no home interest deduction and we aren't interested in capital gains. I have other passive income I can use to deduct rental related business losses.
If you buy the home, you pay $50,000 in interest a year.
If I buy the home and rent it to you, I pay $50,000 in interest, but get a deduction (say I pay 40% in taxes, my net interest after tax is only $30,000).
There is an aribtrage opportunity here: I can rent the home to you for an amount between $30k and $50k, and we are both better off.
In the real world there is a lot more that goes into a decision such as this--interest rates for a homeowner are typically less, and capital gains are a major factor driving real estate purchase decisions. But the analysis is sound in one sense--there is a distortion that is pushing you into renting.
Quote from: Malthus on December 14, 2009, 03:22:15 PM
The odd thing is that while home ownership rates are about the same in the two countries, rates of debt to equity are much higher in the US.
Put this together with the alleged fact mentioned upthread that homes in the US tend to be larger and more expensive, it appears that what US policies encourage is not rate of home ownership per se, but rather ownership of more expensive homes.
I assume your using recent data? We just went though a bubble that saw massive increases in home ownership with little or no money down and a tanking of property values. I would be shocked if we didn't as a nation have higher debt equity ratios.
Quote from: Admiral Yi on December 14, 2009, 03:24:23 PM
Quote from: Malthus on December 14, 2009, 03:13:05 PM
The issue is whether the business getting a deduction or the person getting a deduction for borrowing on the exact same asset is really similar or not.
The business assumes debt to generate a revenue stream. The individual assumes debt to eliminate a cost stream. There may be others factors but that part seems symetrical.
Where you see symmetry I see a fundamental difference.
Quote from: alfred russel on December 14, 2009, 03:26:23 PM
Quote from: Malthus on December 14, 2009, 03:07:04 PM
Here's the standard argument as to why profit-earning businesses should get the deduction while consumption such as housing should not:
http://www.taxfoundation.org/blog/show/1081.html
I disagree with their point of view.
This isn't especially complicated. Imagine that you want to buy a $1,000,000 home with nothing down. 5% interest rate. There is no home interest deduction and we aren't interested in capital gains. I have other passive income I can use to deduct rental related business losses.
If you buy the home, you pay $50,000 in interest a year.
If I buy the home and rent it to you, I pay $50,000 in interest, but get a deduction (say I pay 40% in taxes, my net interest after tax is only $30,000).
There is an aribtrage opportunity here: I can rent the home to you for an amount between $30k and $50k, and we are both better off.
In the real world there is a lot more that goes into a decision such as this--interest rates for a homeowner are typically less, and capital gains are a major factor driving real estate purchase decisions. But the analysis is sound in one sense--there is a distortion that is pushing you into renting.
Seems to me that encouraging business has a different effect than encouraging consumption, even if the business is selling (or renting) stuff being consumed.
Quote from: grumbler on December 11, 2009, 06:29:45 PM
First of all, in Canada, can banks cancel mortgages at will? The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this).
Not really, unless you default on the capital of your loans (you can pay the interests only). The contracts are short terme, not for the whole mortgage period. Maximum is 5 years. What happens is if they don't want you, they ask you to repay the loan when your term period is over (wich they have the right to do).
Quoteother possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).
There is a penalty for repaying your loan early. You can usually negotiate this if you re-borrow from the same bank.
QuoteSecondly, in Canada, are fixed-rate mortgages illegal? the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.
No they aren't.
Quote
I am rather astonished that someone would share such a shoddy article with us. It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! :lol:
The article is bad, inmho.
Quote
The decline of the $US in 2007 had none of the miraculous effects that Frum said it would. :(
Actually, if you take the point of view of the author to be true, you'd need to wait 10-15 years to see the effect of this policy.
Now, if you don't take it for granted...
See, devaluating your currency can be good for exports: your stuff is cheaper, people want to buy cheap stuff.
It worked for Canada because we were selling to the US.
But Canadians and Europeans already buy from the US, no matter the price of your products.
What is happening right now, is that US, Canada and Europe are buying less from America and more from China.
Even if your dollar was worth 0,50$ CAN, I seriously doubt Wal-Mart would be filled with products "MADE IN AMERICA" instead of "MADE IN CHINA", or that my tv would have the mention "ASSEMBLED IN OHIO" instead of "ASSEMBLED IN MEXICO".
Canada was (still is) a small country (population wise) next to a huge neighbour with 10x our population. We have a natural market for export, Americans have a natural interior market.
Besides, even if you try to devaluate your currency, what's to prevent China from devaluating its own currency even more to keep on par?
And about the budget balance... hey, if you want to do it the Canadian way, you'd need regional nationalism to crush, then reduce the transfer payments to States on any and all fields (say, Medicare/Medicaid, education, roads, etc), blame the deficit of the States on their nationalism, pay back your debt, tighten even more your States transfer, wait until New York and Virginia start to raise their voice, then come as savior with check harbouring the US Federal gov't logo to prove everyone how good&nice you are and how lucky your citizens are to have such an effective government and that any hostility toward the central authority is totally misguided and the result of fanatics.
Also, you'd need a previous government who made the tough calls, such as introducing a sales tax on nearly all goods&services (99,9%), selling state property (CN, airport), cancelling military contracts for new helicopters designed to replace the ones you have dating from the '60s, and then instutude a party funding scheme in wich government contractors will bill the government twice for their services while giving back the entire amount of one bill to the Democrat Party as a way to fund their propaganda machine telling every Americans that their country is the "most best in the world" (but well, that part won't be hard, most Americans already believe that :P ) and that a gun registry is essential to prevent kids from playing with nuclear weapons at home.
Quote from: Malthus on December 14, 2009, 03:36:02 PM
Seems to me that encouraging business has a different effect than encouraging consumption, even if the business is selling (or renting) stuff being consumed.
Hell, in the example above why not just structure the transaction as a lease rather than a purchase to take advantage of tax law? That doesn't encourage any business, just tax avoidance.
Quote from: Admiral Yi on December 11, 2009, 06:48:04 PM
I wonder what Frum means when he says Canada "allowed" the currency to depreciate. AFAIK the looney has been floating ever since the end of Bretton Woods. Did Canada stop selling reserves to prop up the value?
Canada did not really "allowed" it's currency to depreciate, in fact, I can recall several interventions by the Bank of Canada to sustain our dollar's value because the gov felt it was sinking too low.
It so happened that our economy was crappy while the US economy was booming.
Quote
I also don't see the connection between the exchange rate and real estate markets.
I think it's 2 seperate points.
Anyway, the only thing to learn from Canada with the present crisis is too not get yourself in out of control debt and only reduce the taxes when you can afford the cut, i.e. not going into deficit to finance your tax reductions.
Of course, one could have also learned the same thing from the Reagan years when the US faced a similar situation at the end of the 80s, early 90s.[/quote]
Quote from: alfred russel on December 14, 2009, 03:44:15 PM
Quote from: Malthus on December 14, 2009, 03:36:02 PM
Seems to me that encouraging business has a different effect than encouraging consumption, even if the business is selling (or renting) stuff being consumed.
Hell, in the example above why not just structure the transaction as a lease rather than a purchase to take advantage of tax law? That doesn't encourage any business, just tax avoidance.
Are you claiming that it is effectively impossible to create a difference in tax treatment between business expenses and expenses for personal consumption, because the latter can always be disguised as the former?
Quote from: Malthus on December 14, 2009, 03:55:07 PM
Are you claiming that it is effectively impossible to create a difference in tax treatment between business expenses and expenses for personal consumption, because the latter can always be disguised as the former?
No, but when we are talking about a need such as housing, I think it is flawed to offer tax incentives for renting but not for buying.
Quote from: Admiral Yi on December 14, 2009, 03:26:02 PM
Holding all other factors constant, the interest deduction should result in similar debt to *after tax* income ratios.
I agree that is the goal of the policy but the problem is that the debt remains in the US while in Canada the debt is paid down so when things go bad the Canuckelhead is not in as much trouble as the Yank who is still burdened by a large debt load he can no longer afford.
In other words, a tax break only works when you have income to shelter....
Quote from: alfred russel on December 14, 2009, 04:01:17 PM
Quote from: Malthus on December 14, 2009, 03:55:07 PM
Are you claiming that it is effectively impossible to create a difference in tax treatment between business expenses and expenses for personal consumption, because the latter can always be disguised as the former?
No, but when we are talking about a need such as housing, I think it is flawed to offer tax incentives for renting but not for buying.
So far, I have failed to observe any particular bad effects from this. What's the downside of such a distortion, in your view?
Quote from: Malthus on December 14, 2009, 04:05:03 PM
So far, I have failed to observe any particular bad effects from this. What's the downside of such a distortion, in your view?
Exactly, I hope he answers this because I see nothing wrong with making rental accomodation more affordable while we have already addressed the problems with creating an incentive for people to acquire and maintain larger debt loads.
Quote from: Malthus on December 14, 2009, 04:05:03 PM
So far, I have failed to observe any particular bad effects from this. What's the downside of such a distortion, in your view?
There is a general principle that the tax code should have a minimal impact on decisions made in the marketplace.
FWIW, I can see a few good reasons not to encourage home ownership. The most important two being that it reduces the mobility of the workforce and creates a kind of real estate lottery for the middle class. In the case of the US, removing the deduction would be a disaster as it would reduce home values and increase the after tax homeowner costs which would fuel more foreclosures and reduce consumer spending.
If you want to avoid high debt levels, I think discouraging home ownership is a poor way to accomplish that. At least in this country, people can spend themselves into oblivion on their credit cards to their hearts content, and they often do.
Alfred-
What you are missing is that the US does not tax the imputed rental value of owner-occupied housing. If the US code did so, then I would agree that the mortgage interest deduction would be justified to create parity of treatment with commercial RE. But it doesn't, and therefore the deduction is simply a pure subsidy that inflates residential housing prices.
Quote from: The Minsky Moment on December 14, 2009, 06:59:09 PM
Alfred-
What you are missing is that the US does not tax the imputed rental value of owner-occupied housing. If the US code did so, then I would agree that the mortgage interest deduction would be justified to create parity of treatment with commercial RE. But it doesn't, and therefore the deduction is simply a pure subsidy that inflates residential housing prices.
You are right and I am wrong.
The one case where I have a point is if the investment property is losing money (rental income doesn't offset the costs of ownership), but there are rules against passive activity losses on real estate (though there are ways around that problem).
Quote from: alfred russel on December 15, 2009, 10:37:01 AM
You are right and I am wrong.
This is the worst thing I have ever read on Languish. For SHAME!