The Proposed Tax Change for Homeownership

There has been a recent proposal for a 15% interest credit for homeowners rather than a deduction of all of the mortgage interest.



Now a credit is a direct allowance off of taxes you owe, but it doesn't effect any of those wonderful measures on what the income cutoffs are for certain other deductions, the way a homeowner's deduction does. On the other hand, there's no "magic" number of dollars of deductions you need to accumulate before it's worthwhile for file a Schedule of Itemized Deductions (Schedule A) as opposed to just taking the standard deduction. So it helps more people, but it helps them less. Furthermore, such a proposal would greatly restrict the amount of property tax that is deductible as well. Right now property tax and the homeowner's interest deduction mutually reinforce (by adding) within the itemized deductions category. Take homeowner's interest out of that, and the deduction for property tax suffers (unless of course, you make that a credit as well). On the other hand, many married couples, particularly in lower cost areas of the country, get no help now from these two deductions where they would on a direct credit. Back to the first hand, most people, particularly homeowners, are above the 15% income tax bracket. So such a move would likely help a few more people, but help those it helps by a considerably lessened amount.



(It is to be noted in passing that none of this makes a direct difference to non-owner occupied property, which falls under a different set of rules)



It has been said (correctly, in my opinion) that current tax policy amounts to a subsidy of real estate prices, in that due to the deductibility of interest and property tax, you are effectively paying less than the "true" market cost of your home, and therefore are being subsidized by the government, and so those with lower interest and property tax deductions are effectively subsidizing those with higher deuctions. Given my political proclivities (vaguely libertarian), I am hardly in a position to argue that taking away this deduction is unjust.



However, this was a choice that Congress intentionally took over half a century ago to subsidize home ownership as a public good. Having just completed preliminary work on a program that gives an honest, complete answer to which of some competing investment options is likely to be better (and fiddled with the assumptions and relationships quite a bit) home ownership has, even without the tax deductions, some advantages that are hard to overcome in the medium to long term. In an area that currently has homes selling for around $500,000, the difference between buying a home and not buying a home can easily get to be well over a million dollars down the line. I knew most of the relationships involved, and I was surprised at how strongly the numbers came out in favor of home ownership.



Now perhaps giving people an incentive to do something that is in their long term best interest (without making it mandatory) has some value in the public policy arena. Nonetheless, when AICPA and other financial planning organizations came out against abolishing the estate tax, I took a point of view that said "If it's good for the clients, it will be good for us" and have stuck with it despite having left the financial planning profession. There are things I'd rather the government do with any prospective money, like index Alternative Minimum Tax to inflation, but if my choice is limited to thumbs up or thumbs down on the idea of abolishing estate tax, both of my thumbs are emphatically up.



In the same light, let us examine whether making this change would be good for the average person.



Married couple with two kids making $36,000 (basically, poverty level) per year between them, with a small mortgage on a manufactured home on an eighth of an acre and light property taxes will see some benefit. If their mortgage is $800 per month and their property taxes $100, their deductions don't hit the minimum to make it worthwhile to file for itemized deductions as opposed to standard. But they could still take the credit. So they would see some benefit of about $1000.



Married couple with two kids making middle class wages of $70,000 per year. Let's say their mortgage is $2000/month and their taxes are $300 per month. Currently, their interest deductions would be about $21,000 from this. depending upon their exact situation, they get the benefit of $21,000 plus $3600 is $24,600, minus $10,000 is 14,600, times 28 percent tax rate is $4088. This would be replaced by a flat 15 percent credit (on the mortgage only) or about $3150. Say bye-bye to almost $1000 per year of disposable income.



Say we have a married couple making $150,000 per year, with $5000 per month of housing expenses. Let's say they can deduct $4600 of it now, or $55200, minus $1000, times 28% tax rate is $12,656 of tax savings. By comparison, the credit would give them (holding assumptions constant) about $7400. Farewell to $5200 for them.



The theme runs consistently. The people it helps see maybe $1000 per year of benefit, and they are actually comparatively few, albeit likely to be lower income. Far more people would be hurt, many of them significantly, although the argument can certainly be made that they can afford it more. I don't think anybody feels a huge amount of intense sympathy for a couple making $250,000 per year that that lose $10,000 of it either via this proposal or a limit on the mortgage interest deduction (unless, of course, they're the $250,000 per year couple).



So on a social benefit model, this looks like a definite loser on the balance. If we're talking ridding ourselves of subsidies, the 15% credit is a subsidy too, albeit a lesser one, and I'll bet (sight unseen) that there will be ways to game it.



Disclosure: I'm in real estate. Professionally, I'll admit I want prices to continue to rise, all other things being equal.



Nonetheless, the amount of screaming out of various real estate organizations since this proposal first aired, you'd think it was the apocalypse or something. It's not. Investors may get hit, which I'd rather not happen, either, but they're not the ones the deduction is aimed at. The same goes for speculators holding the bag at the wrong time. I've seen a couple of accusations hurled at the Bush administration that this is largely a blow aimed at the heavily Democratic real estate industry, much as I also saw accusations leveled at the Clinton administration that they were taking shots at the heavily Republican financial planning industry. I think both sets of accusations are about equally valid. But from a real estate function, both agents and loan providers are going to continue to do just fine, and we're not the ones this piece of public policy is aimed at, either.



The thing I most want is a wealthier public. I'll admit that I don't see how changing this will make the public wealthier - if anything, somewhat the reverse - but if it can be shown, or designed such that the public becomes wealthier by it, then those in my profession and allied ones are the least of my concerns, because any time the home owning public gets wealthier, so do we.