“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.

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