Correa fights to extend tax relief to Californians mired in mortgage debt

As any Californian will tell you, the housing crisis which hit the country has had particularly nasty effects on homeowners in States with high property values. And while California carries mercifully low tax rates for homeowners thanks to the existence of Proposition 13, this does little to alleviate the woes of people struggling with a more onerous and privately imposed burden – namely, their mortgage.

In response to this problem, one oft-employed strategy by homeowners is to “short sell” their homes. The term “short sell” refers to a process whereby homeowners sell their homes at a lower price than they bought it so as to make up a large amount of the difference in paying off their mortgage debt. The problem from an economic perspective is, of course, that this leaves them with very little in the way of consuming power, since all that results is a situation whereby the short sellers in question have lighter pockets.

In response, State Sen. Lou Correa (D-Santa Ana) has come up with an idea whereby the negative effects of “short selling” could be blunted. According to the OC Watchdog Blog, Correa and several other state legislators are pushing Governor Schwarzenegger to sign off on a proposal to extend tax relief to short sellers. “The stakes are higher than just short sales,” Correa said, according to the Watchdog. “This deals with short sales, loan modifications and foreclosures.”

The idea is not unprecedented, as the Federal Government currently offers tax relief as a means of mortgage debt forgiveness. According to the Watchdog, “California, unlike the federal government, no longer offers tax relief for mortgage debt forgiveness. Debate in Sacramento has primarily focused on the impact this change has on Californians who sell their home at a loss, otherwise known as a ‘short sale,’ but Correa said in a press conference this morning that residents who foreclose on their homes or secure a loan modification also could be on the hook for large tax bills from the state.” In other words, if Correa et al are to be believed, the State adds insult to injury when short sales occur, only further deteriorating the consuming power of its residents, and reducing the prospects of economic recovery.

That Correa’s proposal would be a politically popular move is not in doubt – what is in doubt is whether he can manage to stop partisan opportunism from spoiling it. A previous and similar proposal was recently vetoed by Governor Schwarzenegger with the acid statement that “I asked you to send me legislation that protects homeowners from being taxed on ‘short sales’ when they are forced to sell their home for less than they owe on their mortgage. Instead you are sending me a bill that uses these homeowners as leverage to increase tax penalties for businesses. Send me a clean bill that protects homeowners from this tax immediately, and I will sign it.”

To the uncharitable reader, then, Correa’s proposal seems unlikely to succeed because the Democratic legislature will not stop itself from trying to insert stealth taxes.  The Democratic legislature protests, in response, that it is only following Federal precedent set by the Bush administration, but what is not clear is why this argument has any bearing on the economics of Schwarzenegger’s veto – that is, the Bush administration policy was written during a time when economic prosperity was not in question, or at least not to the degree that it is now.

Correa rightfully protests that the “partisan wrangling” should stop on the issue, but such a wish seems unlikely to be met for the duration. Fortunately, Correa does not appear poised to give up.