How to Cripple the Labor Market and the Housing Market in One Simple Step

The Obama Administration continues to find new ways to keep the unemployment rate at European levels. The other day it announced that

Loan servicers collecting payments on FHA-backed loans must allow qualified borrowers who lose their jobs to miss up to a year of mortgage payments before starting foreclosure proceedings against them.

Just think for a moment about what a huge disincentive this is for an unemployed homeowner to accept a new job that involves a significantly lower salary than his previous job. Suppose that when “Ed” took out his mortgage he was making $90,000 a year, and his mortgage payments made up a third of his income. Now suppose that the best job Ed can find in the current economic situation pays $75,000. If Ed takes the job, then after deductions he’ll probably pay somewhere around $8,000 in federal and state income taxes. After mortgage payments, Ed’s family will have about $37,000 to spend on other goods and services. On the other hand, if Ed turns down the job offer, he won’t have to pay anything in taxes or mortgage payments for a year, while staying in the house. He and his family will, however, have to make do with unemployment benefits and drawn-down savings.

Suppose that Ed qualifies for $400 a week in unemployment insurance for a full year. If he remains unemployed, his family will have about $20,000 to spend on non-housing consumption over the coming year. Notice that if Ed takes the hypothetical job, he’ll only increase his family’s total consumption by $17,000 for the year. What this means is that the effective marginal tax rate facing Ed is not the statutory rate of 25%, let alone the average rate of about 10% or so, but 77 percent. Even if he were to find a job at exactly his old salary, his effective marginal tax rate would be about 67%. And under these hypothetical numbers, a job that pays no more than $50,000 leaves Ed and his family worse off than if he remains unemployed. You can form your own conclusions about just how hard Ed will search for work when facing what are essentially punitive tax rates. But standard economics suggests strongly that Ed, like others in his situation, will not tend to look as strenuously for work when their reward for doing so is something on the order of a 75% tax. Would you?

And if you were in charge of mortgage lending for a bank trying to remain solvent, just how eager would you be to issue new mortgages in a world where federal agencies are always ready to prevent you from foreclosing on bad loans? And if lenders don’t want to lend, how exactly is the housing market going to rebound?

Once again a rational observer must wonder if the Obama Administration can really be so very full of very stupid people.

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