“Gaming” the First-time Homebuyer Credit program

The $8,000 First-time Homebuyer Credit program has been riddled with fraud and abuse, in ways the IRS didn’t foresee or try to control. Here’s the story, and a handful of ways they could have sought out such “unintended consequences.”

A recent Washington Post story outlines how hundreds of millions may have already been paid out to people who fraudulently or mistakenly took advantage of the first-time homebuyers’ $8,000 tax credit funded under the American Recovery and Reinvestment Act of 2009:
• 19,300 people claimed $139m on their 2008 tax returns
• 74,000 people claimed nearly $500m for unqualifying purchases
• 580 people under 18 – including 4 year olds – claimed $4m

Of course this is small potatoes – perhaps 1.4m households have claimed almost $10B in tax credits. And the Congress is rushing to extend the tax credit provision, proving again that “fraud, waste, and abuse” are in the eye of the beholder.

But the IRS has identified 160 potential tax credit schemes and selected 107,000 claims for reexamination. So they’re looking at 7.6% of those claiming the credit! What a waste of resources, if these problems could have been headed off at the pass!

[NB: Our concern here is the mechanics of program design, not (a) whether the program was a good idea, or (b) whether it has jumpstarted the housing market.]

The Post story and the House hearing it reported on were based on a report by the Treasury Department’s Inspector General for Tax Administration. The Inspector General asked the usual questions: (a) What happened, and (b) What can be done about it?

The first page of the IG report notes that “the President’s mandate with regard to stimulus payments is to prevent fraud, and not simply minimize it or address it after it has occurred.” Prevention is a hallmark of Inspectors General; it even appears on their website, sponsored by the unfortunately named Council of the Inspectors General on Integrity and Efficiency (CIGIE calls up “ciggies” — where was The Acronym Control Team?}

It was only 100 years ago that philosopher George Santayana said, “Those who cannot remember the past are condemned to repeat it.” We also need to understand the past. This leads to two more questions: (c) How did it happen, and (d) How can we prevent similar problems in the future?

The problem, simply stated, is that Treasury is offering substantial sums to countless potential takers without finding ways either (a) to prevent fraud or error, (b) to discourage it, or (c) to make it easily discoverable after the fact.

This has had the effect of increasing both fraud and abuse, and also increasing substantially the efforts that the IRS must undertake subsequent to the claims being filed. It is worth noting that Ashby’s Law clearly applies here: the taxpayers outnumber the IRS, so prevention will be much, much easier than remediation.

The IRS did develop a special form (Form 5405) to catch claims in excess of that allowed and claims by those with adjusted gross incomes above the set limits, as well as claims without Form 5405 attached (Duh!). The IRS, however, did not use the Form 5405 to verify eligibility and no proof of a home purchase was required, such as the ubiquitous HUD-1. Both had been recommended by the Inspector General.

So that’s WHAT happened. But HOW did it happen? As it is, we have no idea whether anyone tried to think through the likely results of their program design, or cast about looking for unintended consequences. Appendix I of the report is silent on any inquiry into the thought processes of the IRS staff who designed the tax credit program, and unless the redacted portion of Page 5 hides some names, we have no idea who was involved in the decisions.

Of course, the Inspector General could assign pseudonyms to the actors in this horror story; perhaps “Mary Shelley” as an Assistant Commissioner, “Edgar Poe” as a career staffer, “Sarah Langan” as the staff director of the relevant congressional committee, and “Bram Stoker” as an Associate General Counsel. Then their deliberations could be revealed while safeguarding their identities.

But if anyone HAD BEEN looking for ways to search out unintended consequences, here are a few ways they could have done so, ranging from the obvious to the quite innovative:

1. Ask those directly involved to think of possible unintended consequences over the weekend and come to a meeting on Monday to address that subject only.

2. Assign a small staff group to collect and present possible problems in a meeting with program advocates, with the political appointee acting as “referee,” not as advocate for any one view. This is a variant of “redteaming,” as practiced at the Pentagon or even in theory at the Federal Aviation Administration (example).

3. Ask staff at “the point of the lance” what could go wrong. Field staff have a different perspective on what can happen in “practice” versus in the “theory” as developed by headquarters.

4. Assemble the Senior Executives from across Treasury who have received Distinguished Rank Awards. (See note) This group has more years in the pay line than the immediate office has in the chow line, and can bring that experience to the problem at hand.

5. Email a description of the proposed program for comment to a handful of members of the relevant “policy communities” around Washington, whether the Brookings/Cato/AEI group or the Booz/IBM/Deloitte group, or both.

6. Post the description on an open internet site, asking for insights from the world at large. Let anyone comment, or even become Facebook “fans” of Tax-Breaks-For-First-Time-Homeowners.

In all likelihood, “None of the above” was the option chosen.

BTW, my preferred solution would have been (a) to have the buyers execute a form before a Notary Public swearing to the facts entitling them to the tax credit, and (b) to have that form registered along with the new deed and mortgage at the county land office.

I’d guess that far better solutions would have arisen from almost any of the methods outlined above.

PS: A friend suggests that the IRS check the claimant’s recent filings to see if mortgage deductions were taken during past years. That would certainly help!


Note: Distinguished Rank Awards. There are about two million career civil servants. About six thousand of these (0.3%) have been promoted, based on merit, to become members of the Senior Executive Service. About sixty members of the SES (thus only 0.003% of the two million) are given Distinguished Rank Awards each year, based on nominations by their departments and agencies. Few groups know more about the federal government, and few are less often asked for their opinions of how to improve it.

Disclaimer: I received one of the awards in 1996.

Lighting the candle, cursing the darkness.

The Big Idea behind this blog, perhaps not always apparent, is that (a) given government’s role in tipping the scales of society more toward life, liberty, and the pursuit of happiness, and (b) the apparent and undoubted increases in the nature and complexity of the challenges of the 21st century, then (c) government should take full advantage of ALL of the science and technology available when intervening in society’s workings.

My hope here is to light the occasional candle, even if that means cursing the darkness. I bring a passing acquaintance with the new sciences and technology, as well as a broader exposure to the Federal government than anyone living. See the “About” section above.

Of the sciences overlooked, first and foremost are the sciences of complexity and the systems sciences developed around the time of WWII. Norbert Weiner and cybernetics come immediately to mind. There are many others, from game theory to highly reliable organizations. As historian William H. MacNeill observes in The Pursuit of Power, science and technology always advance in time of war. The casual reader of this blog and observer of the US Congress will note that our legislative process is several wars behind.

The philosopher George Santayana famously said in 1905, “Those who do not learn from history are doomed to repeat it.” Given just the threats to the world economy from unstable economic systems and the threat to the planet from global climate change, ‘repeating history’ is totally UNSAT.

As Justice Oliver Wendell Holmes, Jr., (1841 – 1935) once remarked, “In the law, an ounce of history is worth a pound of logic.” In lawmaking, the ounce of history is often diluted, and a pound of logic is insufficient to foresee the unintended consequences of legislation in an increasingly complex society. Jay Forrester devoted a chapter of his 1969 book, Urban Dynamics, to the ‘counterintuitive behavior of social systems’, which is also the title of a paper he wrote in 1971, based on testimony to the Congress in 1970 – almost forty years ago.

A recent article in the Economist points out that India’s monsoon rains are becoming “even more compacted and unpredictable,” leading both to drought and flooding. At the same time, groundwater extraction, subsidized by free and below-cost electricity to farmers and city dwellers alike, is already curtailing agriculture: “The World Bank reckons that 15% of India’s food is produced by “mining”—or unrenewable extraction of—groundwater, including in 18 of Punjab’s 20 districts.” Some politicians have been punished for proposing charging for electricity, and others have learned their lesson.

India invested in big dams and canal projects in the 1950s – 1970s, thus “paving the way” for India’s Green Revolution. Sadly, little to no resources are spent on maintenance. According to the article, India’s primary response to the water problems is to build more large dams (390 are under construction), rather than repair the existing infrastructure or reform its use. There’s no mention of money for maintaining the new dams, either.

If this sounds familiar, it is. America is also keen on building infrastructure, but not as ready to maintain it. There are few photo opportunities for road repair projects. The American Society of Civil Engineers publishes an annual Infrastructure Report Card that this year gives America a grade of D and estimates that our five year investment need stands at $2.2 trillion. This year’s stimulus bill is, so to speak, a drop in the bucket.

Even though the Dow passed 10,000 this week, no one seems to think that the American economy is out of the woods, or much less that we’ve learned enough or taken action to prevent the Wall Street wolves from getting Little Red Ridinghood again. The fabled “stress tests” on the 19 “systemically important” institutions were done assuming an unemployment rate of just 8.5%, and we’re now at 9.8% — and aiming for at least 10%.

So we’re still in uncharted territory. Might the new sciences provide us a GPS (Growth Producing System) or at least be our Mapquest out of the woods??

Two recent articles in the Economist, “Rearranging the Towers of Gold” and “Unnatural Selection” do an excellent job of describing the problem(s), but are not as clear about how to address the (hopefully) unintended consequence of the tax-payer-funded “recovery” — that the institutions “too big to fail” last year are even bigger now!

After the Great Depression, the eponymous Pecora Commission proposed legislation, including the Glass-Steagall Act, and the Securities Exchange Act of 1934, that created the Securities and Exchange Commission. Together they led us down a sometimes rocky road, but one without landslides.

Many are now calling for the reinstatement of the Glass-Steagall Act, repealed in 1999 in an effort led by Senator Phil Gramm (R, TX), now a Vice President of the Investment Bank division of UBS AG. Although at first glance separating the investment and commercial bank interests in the industry would seem necessary, it may be far from sufficient to avoid another meltdown like this one. The world – especially the world of finance – has gotten much more complex and interdependent in the years since 1932. We’ve added computers with worldwide telecommunication, f’rinstance. Faster feedback loops are not always better.

Our jigger of history has brought us the Financial Crisis Inquiry Commission, headed by Phil Angelides, a former California state treasurer. As expected, neither Common Dreams’ comments nor those of the Huffington Post hold out much hope for this panel. Sadly even the New York Times, in a recent editorial, offers at best faint praise.

My concern is that in hearkening back to the Pecora Commission, even friends of the “Angelides Commission” (which already has “about 1800 hits” on Google) are taking aim at the problems of the 1930’s. I see nothing in Mr. Angelides’ bio that gives me confidence that he knows much about the counterintuitive behavior of social systems, cybernetic feedback, system dynamics, high reliability organizations, game theory, chaos theory, or the new discipline of complexity, to name just a few of the disciplines needed for diagnosing, much less prescribing for, our ailing financial system. A quick look at the other members does not offer much hope, either. And we know little about the commission’s staffing.

The new commission would be miles ahead by convening a few of the people that I know, such as George Richardson and Paul Pangaro. Just these two, and their immediate contacts, would be able to frame a 21st century conversation bringing new insights to a search for how to stabilize our economy. There are many other knowledgeable people out there, in business, in universities, and in associations such as the American Society for Cybernetics and the System Dynamics Society. We need their help to do even half as well as the Pecora Commission.

Or, we can do as the Egyptian government did recently – take action even after being told what the unintended consequences would likely be. As recounted in the New York Times, Cairo ordered the slaughter of all the pigs in the city, even after being told that (a) it would have no effect on “swine flu,” and (b) the pigs were responsible for eating tons of the organic waste discarded in the streets by its residents. So now Cairo’s streets are worse than ever.

From the Times: “The state is troubled; as a result the system of decision making is disintegrating,” said Galal Amin, an economist, writer and social critic. “They are ill-considered decisions taken in a bit of a hurry, either because you’re trying to please the president or because you are a weak government that is anxious to please somebody.”

Let’s hope the Angelides Commission can do better.

It IS “rocket surgery,” but it’s not impossible.