Tax Breaks for Bubble Heads

From Wall Street to Orange County, from the exurbs of Dallas to the South Beach strip, a cry is rising from throughout the land: something must be done about the nation's housing market!

Washington has been struggling mightily to respond. The Federal Reserve is promiscuously extending credit to banks and Wall Street; Fannie Mae and Freddie Mac are boosting the size of mortgages they'll buy, and the White House has orchestrated a voluntary industry effort to stave off the rising tide of foreclosures. Concerned that these extraordinary measures still aren't sufficient, the president and Congress are now considering new moves to help the beleaguered industry, with the Senate set to vote tomorrow on a package of new tax breaks and assistance.

Even with this flurry of activity, many critics, particularly Democrats, have argued that the government isn't doing enough. But the package under consideration suggests that it may be doing too much. The bill includes several items that are likely not to do much harm—boosting deductions for property taxes, tax-exempt bonds for local housing agencies, and modest tax credits for people who buy homes out of foreclosure. But it also includes a provision, detailed in this Associated Press story, that is perverse, absurd, and unwarranted. In short, I don't think it's a good idea.

Under the proposal, the AP reports, "companies would for two years be allowed to carry back losses incurred in 2007 and 2008 against profits accrued over the previous five years, instead of the usual two year timeframe." Under current rules, companies can effectively call up the Internal Revenue Service and declare a do-over, applying losses racked up in 2008 against income reported in 2007 and 2006, and then claim a retroactive tax refund. The utility of this benefit rises as the size of the loss increases. If, for example, you're forced drastically to write down the value of land you've acquired, the loss in 2008 could easily swamp the profits reaped in 2007, 2006, and several years before.

The technical term for this is a tax-loss carryback. But it should perhaps be known as a bubble-head tax break. Companies that vaulted into a hot sector and then used lots of leverage to increase their profits in said sector (the Internet, real estate) light up the charts during the boom years. But come the pop, their fortunes plummet rapidly down the same steep slope. And because accounting rules require companies to mark assets to market, erstwhile high-flyers frequently report massive losses.

The proposed tax break is hard to justify for several reasons. It does nothing for slow and steady companies that keep their heads and simply rack up profits year after year—and pay their taxes accordingly. Rather, it rewards the most reckless participants in the bubble. If you borrowed a ton of money to build spec houses in Miami and reported $2 billion in profits between 2002 and 2007 but gave up all those profits by notching a $2 billion loss this year, the extended carryback has a great deal of value. If you've been building affordable housing in Wichita, Kan., and booked $300 million in profits in those years, and then, through careful management of costs, managed to eke out a $5 million profit this year, it has no value. The big public homebuilders, whose shares rallied on the news of this potential tax break, didn't pay any windfall taxes on the bubble-era earnings. Why should they get an extraordinary post-bubble windfall?