A $5,OOO Cat? - The NRST and Real Estate

NRSTA - Virginia Chapter ^ | N/A | Steve Hayes

[Remember_Salamis]

A $5,OOO Cat? The NRST and Real Estate

By Steve Hayes President, Citizens for an Alternative Tax System

Once Johnny came home with a puppy that he had found at the park. His father told Johnny that he couldn't keep the dog. Johnny protested but his father was unrelenting.

Tearfully, Johnny agreed. He took the puppy and left and was gone about an hour. When Johnny returned his father asked what became of the puppy. Johnny said that he sold it for $10,000.

The father demanded an explanation. Johnny said that he had gone to the neighbor's home and sold the puppy for two $5,000 cats.

Many in Washington explain everything that they do for us in glowing terms. They refer to the great benefits reserved for us in the tax code.

However, often when we examine the manna from Washington we find that the supposed benefit isn’t as good as we were promised. The benefit from Washington all too often really resembles one of the boy's $5,000 cats.

An example of this is the mortgage interest deduction. The fact that this benefit will be repealed by the national retail sales tax ("NRST") is one of the major objections used by opponents of the NRST.

Is the mortgage interest deduction really a "great" benefit or a $5,000 cat? The mortgage interest deduction is a provision in the federal income tax code which permits the deduction of the amount of mortgage interest paid on your home mortgage from taxable income, the amount of income on which federal income taxes are calculated.

Washington bureaucrats and realtors trumpet the tax advantages that accompany home purchases. "Buy a home and get a 'tax shelter' like the 'big guys' ". Alas, the "mortgage interest tax shelter" is, for many Americans, a $5,000 cat.

Here is an illustration of the home mortgage deduction. Fred and Joan Jones have two children and an annual income of $60,000. On January 1st, they buy a home a home for $140,000, pay $14,000 down and obtain a $126,000 30-year mortgage at 7 percent interest. The monthly mortgage payments are $838. Fred and Joan will pay mortgage payments of $10,059 in year one. Of the $10,059, $8,780 is interest and $1,279 is principal, which under the present federal income tax is not deductible. {1}

At the end of the year, eager to take advantage of this great "tax shelter, the Jones family deducts the mortgage interest paid of $8,780 from its taxable income of $60,000 and $10,600 of personal exemptions {2} leaving a new taxable income of $40,620. By deducting the $8,780 of mortgage interest the Jones family will pay $6,094 in federal income tax. {3}

At first glance, this would seem to be a real benefit. Fred and Joan were able to reduce their taxable income by the amount of the mortgage interest they paid. They know that their top marginal federal income tax rate is 15% so they appear to have received 15% of $8,780, or $1317, of the money that they would have paid in federal income taxes back from the government. However, in order to utilize the "mortgage interest tax shelter", they must file a 1040 return and itemize deductions. Interestingly, most real estate agents don't explain this fact but, without itemizing, the Jones family would have been able to take what is called the standard deduction that is available to everyone whether they pay mortgage interest or not.

"65,400,000 Americans are home owners but only 29,396,016 Americans take the mortgage interest deduction. For many of these 29,396,016 Americans the benefits of the mortgage interest deduction are marginal and more illusory than real."

If they had not deducted the $8,780 in mortgage interest payments but simply taken the standard deduction, Fred and Joan would have paid $6,551 in federal income taxes. This means that the mortgage deduction actually only saved them $457 in federal income taxes over what they would have paid if there was no mortgage deduction. On top of this, filing a return and taking the standard deduction generally means that you are less attractive to the IRS for an audit. So, the Jones family filed a more complicated return and increased their odds of an IRS audit to save $457. {4}

Another point that needs to be understood is the idea of "after tax expenditures." These are expenditures which, unlike the mortgage interest deduction, are not subtracted from our taxable income when computing taxes. These are items for which we have to earn enough to enable us to pay the income tax and still retain the net amount to be spent. Since the Jones family is in the 15% marginal tax bracket, in order to have a dollar to spend they will have to earn $1.18 and pay 18¢ in federal income tax (15% of $1.18) to net $1.00. As stated earlier, $1,279 of the total mortgage payments in year one is principal which is not deductible. The $1,279 of principal payments in year one is paid from the money that Fred and Joan have after payment of their taxes. To Fred and Joan, this means that they had to earn $1,505, pay $226 in federal income taxes (their marginal income tax rate is 15%) in order to net $1,279, the amount they paid in principal on their mortgage.

To recap, Fred and Joan have earned $60,000 and the examples shown in figure 1 illustrate the actual benefits they received from the mortgage interest deduction.

With Mortgage Deduction Without Mortgage Deduction

$60,000 $60,000

- 4,590 FICA {5} - 4,590 FICA

- 6,094 Federal Income Tax - 6,551 Federal Income Tax

- 10,059 Mortgage Payment - 10,059 Mortgage Payment

$39,257 Net Amount Remaining $38,800 Net Amount Remaining

Figure 1.

Assuming their income goes up at 3% per year, in 5 years they will be making $67,531 but will only be saving $406 more than they would be saving if they utilized the standard deduction. {6}

The amount of income tax savings is decreasing because the amount of interest is less each year and the amount of principal increases each year. The amount of mortgage interest paid in the fifth year will be $8,367 and the amount of principal will be $1,692.

The Jones family cash flow will then be:

$67,531 - 5,166 FICA {7} - 8,245 Federal Income Tax - 10,059 Mortgage Payment $44,061 Net Amount Remaining

However, if Fred and Joan want to actually own their home they will see a rapidly decreasing benefit from the mortgage interest deduction as they pay down the loan. In fact, by the 14th year, it will be better for Fred and Joan to take the standard deduction of $6,900 rather than the standard deduction of $6,900 rather than the mortgage interest deduction of $6,888. {8} Moreover, if Fred and Joan had purchased a home with a mortgage of $99,000 instead of $126,000, they would have saved nothing from the mortgage interest deduction.

This is one of the primary reasons that 65,400,000 Americans are home owners {9} but only 29,396,016 Americans take the mortgage interest deduction.{10} For many of these 29,396,016 Americans the benefits of the mortgage interest deduction are, like for Fred and Joan, marginal and more illusory than real.

If they actually pay the mortgage on their $140,000 home, Fred and Joan will have paid $175,781 in interest and $126,000 in after-tax principal for which they would have had to earn $148,000 and pay $22,000 of federal income taxes to net $126,000.

Contrast the above scenario with the situation if Fred and Joan purchased their home after the passage of the NRST using the same purchase price and 30-year mortgage at 7% interest.

Fred and Joan will receive their income without any income tax withholding. They, not the bureaucrats in Washington, will decide how much income tax they pay by how much they elect to spend on retail purchases. No longer are Fred and Joan treated as children or mentally deficient adults but as adults capable of making their own decisions.

Fred and Joan receive $58,234 in income, which is the earnings of $60,000 reduced by $4,590, the amount of the FICA withheld and increased by $2,824, the amount of the NRST rebate {11} to a family of four. Like under the federal income tax, the NRST will tax the principal of the house purchased by Fred and Joan. Under H.R. 2001, the bill introduced by Congressmen Dan Schaefer (R-CO) and Billy Tauzin (R-LA) that replaces the income tax and the IRS with an NRST collected by the states, the $140,000 purchase price of the house will be taxed by the NRST, resulting in a tax owed of $24,706. This tax can be paid either at the time the house is purchased or over a 30-year period. If the election is made to pay the $24,706 over 30 years then Fred and Joan will pay $73 per month or $876 per year.

The $8,780 of mortgage interest will not be subject to the NRST. {12} At the end of year one we see the results shown in figure 2.

NRST Federal Income Tax

$60,000 $60,000

- 4,590 FICA - 4,590 FICA

- 876 NRST Payment on the Principal - 10,059 Mortgage Payment

- 10,059 Mortgage Payment $44,991 Net Amount before Income Tax

+ 2,824 NRST Rebate - 6,094 Federal Taxes

$47,299 Net Amount before NRST --

- 6,345 Estimated NRST {13} --

$40,954 Net Amount Remaining $39,257 Net Amount Remaining

Figure 2.

After 5 years under the NRST, and assuming a 3% increase in their income, Fred and Joan would have the following net amounts of money under the NRST and the present income tax as shown in figure 3.

NRST Federal Income Tax

$67,531 $67,531

- 5,166 FICA - 5,166 FICA

- 876 NRST Payment on Principal - 10,059 Mortgage Payment

- 10,059 Mortgage Payment $52,306 Net Amount before Income Tax

+ 2,824 NRST Rebate - 8,245 Federal Income Tax

$54,254 Net Amount Remaining --

- 7,388 Estimated NRST {14} --

$46,866 Net Amount Remaining $44,061 Net Amount Remaining

Figure 3.

Now, we have assumed that the interest rate to be paid by Fred and Joan would be the same under the present income tax and the NRST.

This is really not the case. Economists agree that interest rates under the NRST will decline by at least as much as the difference between the municipal bond rate and the standard, non-tax free bonds. Some believe that the reduction will be much greater as America becomes the greatest place for investment and funds flood into the United States from all around the world. However, if we just assume the smaller reduction this will mean that the mortgage rate will be not 7% but 5.5%. {15}

This would mean that the mortgage payments and total cost of the mortgage for Fred and Joan would be reduced. Below are comparisons of the present income tax and the NRST with the lower interest rate. Here is a recap of the new costs and the comparison shown in figure 4.

NRST Federal Income Tax

$60,000 $60,000

- 4,590 FICA - 4,590 FICA

- 876 NRST Payment on the Principal - 10,059 Mortgage Payment

- 8,585 Mortgage Payments $45,351 Net Amount before Income Tax

+ 2,824 Rebate - 6,094 Federal Income Tax

$48,773 Net Remaining before NRST --

- 6,166 Estimated NRST {16} --

$42,607 Net Amount Remaining $39,257 Net Amount Remaining

Figure 4.

This means that the total cost of paying off the mortgage under the NRST is $131,548 of interest, $126,000 of principal and $24,705 NRST tax for a total of $282,253. Contrast this to $323,781, the amount that would have to be earned and spent under the federal income tax, a difference of

$41,258.

Yet another factor we have not addressed is that under the NRST, it will be much easier for Fred and Joan to save the money needed to purchase their home. Under the present income tax in order for Fred and Joan to save the $10,000 that they need for the down payment on their home, they will have to earn $11,765 and pay income taxes of $1,765 to net $10,000. If they deposit the money in a savings account then the interest will also be taxable.

However, under the NRST, Fred and Joan will only have to earn $10,000 and save that amount because earnings are not taxable under the NRST. Any interest earned on a savings or investment will not be taxed under the NRST. The NRST gives Fred and Joan the ability to keep all the money that they don't spend whether the source is earnings or a return on their savings and investment.

There are a number of other things that we have not taken into account when we do our comparison. The foremost of these is that the economic studies that have been done on the affect on the rate of growth in the economy after the enactment of the NRST all show increased rates of growth and increased rates of productivity. This is very important because increases in income are derived from increases in productivity.

What does the increased economic growth mean to each of us? If the economy had grown at the same rate since 1973 as it did prior to 1973, the average family would have an additional $10,000 per year in disposable income.

It is time for Americans to quit accepting $5,000 cats and demand a tax system that really works for America, the NRST.

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FOOTNOTES

{1} This is omitting the cost of any private mortgage insurance.

{2} Each family member receives a $2650 personal exemption or $10,600 for a family of four.

{3} For purposes of our example we are not considering any deductions that might be available would increase the amount of itemized deductions because these vary widely among taxpayers.

{4} The $457 in savings would be increased if there were additional itemized deductions like real estate taxes, state income taxes and charitable donations. For example, if Fred and Joan had an additional $1000 of deductions then they would have saved an additional $150 in their 15% income tax bracket.

{5} Federal Insurance Contributions Act

{6} This actual savings from the mortgage deduction will likely be less because the standard deduction will also have been increased.

{7} This assumes that the FICA will be assessed on $67,531.

{8} Again, this is assuming that the standard deduction for a family--of four remains at $6,900 which it will not. Therefore, the standard deduction will likely exceed the mortgage interest several years earlier.

{9} U.S. Census Bureau

{10} Statistics of Income Bulletin, published by the Internal Revenue Service

{11} The NRST rebate is determined by family size. It provides a rebate to Americans equal to the NRST on their purchases up to the poverty level. For a family of four this would be a rebate on the first $16,000 of purchases.

{12} Fred and Joan are paying the NRST on the principal over 30 years.

{13} Fred and Joan would not pay NRST on the FICA payment, the NRST payment and the mortgage payment. We are assuming that the family has savings or expenditures of an additional $5,000 not subject to the NRST - like charitable donations, education expenses or savings.

{14} We are making the same assumptions as in footnote 13.

{15} Many economists believe that the mortgage interest rate will likely be even lower because of the increase of savings and the infusion of vast amounts of capital from around the world.

{16} This assumes that the family saves or spends a total of $5,000 on items not subject to the NRST.

[kevkrom]

BTW, for those interested in how to do the calculations...

re = t / b
ri = t / ( b + t )

That is, the tax exclsuive rate is the amount of tax divided by the basis; the tax-inclusive rate is the amount of tax divided by the basis plus the tax.

For a sales tax, the basis is simple -- it's the pre-tax price of the item. For income taxes, the basis is actually the post-tax income, i.e., income - taxes. Substituting ( i - t ) for b in the above formulas:

re = t / ( i - t )
ri = t / ( i - t + t ) = t / i

[Your Nightmare]

Your receipt is wrong because the nrst is figured exclusive of any state or local taxes.

Actually, you're wrong, but it's hard to tell with the tax inclusive rates. I just had a typo on the cost of the item. It should have been $29.65. Other than that, the numbers are correct...and confusing.

The corrected receipts:

Item description	$ 29.65
8.25% sales tax	2.44
TOTAL	$32.09

With a NRST, this receipt becomes:

Item description	$ 29.65
8.25% state & local sales tax	2.44
23% national sales tax	8.85
TOTAL	$40.94

[Your Nightmare]

So what's the beef? Do you call people deceptive for using inches instead of feet? The distance is the same, just different units....

The beef is that NRST supporters rarely mention what "units" they are using (see Saxby Chambliss and John Linder's article in the Atlanta Journal-Constitution). They just mention the percentage leaving uninformed people to mistakenly believe a 23% sales tax is the tax exclusive "unit" they are familar with.

I'm sure it's just a coincidence that the inclusive rate is lower than the exclusive rate.

[kevkrom]

A couple of things about your receipt. First of all, if the state is administering the NRST, the state sales tax would conform to NRST definitions. This would dramatically lower the rate, as it increases the base of what the state sales would cover.

Secondly, the price for the item before federal taxes will be less than the pre-NRST price that includes federal taxes and their affects. It doesn't really matter from the standpoint of confusion, but I thought I'd just throw it out there as a reminder.

Now, I'd agree with you that on the receipt, the tax-exclusive form should be used (the legislation explicitly calls for the tax-inclusive version). The main reason why is that the tax-exclusive rates for federal and state can be added together to get the effective tax-exlcusive rate. This is not true for tax-inclusive rates. For example:

Assuming tax-exlusive rates of 30% and 5% for federal and state, on a $100 (pre-tax) purchase, $30 federal sales tax and $5 state sales tax are collected. The total tax is $35, which is 35% of $100, and equal to 30% federal plus 5% state.

Now, if tax-inclusive rates are used, the federal rate is 23% and the state rate is 4.8%. The total tax is still the same, but it works out to 25.9% tax-inclusive, which is lower than the sum of the 23% and 4.8% individual rates.

In short -- while comparing NRST rates to income/payroll taxes, I prefer using tax-inclusive for equitable comparison, but for receipts, tax-exclusive makes more sense for readability.

[Your Nightmare]

First of all, if the state is administering the NRST, the state sales tax would conform to NRST definitions.

Why?

[kevkrom]

It's in the legislation. If a state adminsters the NRST it must conform. That means no state income taxes (without mooching off the IRS forms, it will be hard for states to maintain their present income taxes anyway) and a sales tax without certain items exempted.

[Your Nightmare]

It's in the legislation. If a state adminsters the NRST it must conform. That means no state income taxes (without mooching off the IRS forms, it will be hard for states to maintain their present income taxes anyway) and a sales tax without certain items exempted.

Can you show me where this is in the legislation?

[kevkrom]

Can you show me where this is in the legislation?

Actually, I can't seem to find it. Perhaps this year's version of the bill has been modified, or I'm just missing it. There are sections that refer to conforming states (states adminsitering the NRST and conforming their own rules to the NRST definitions), but I can't seem to find the requirement.

[Your Nightmare]

NP. That one was new to me.

[Principled]

The beef is that NRST supporters rarely mention what "units" they are using (see Saxby Chambliss and John Linder's

Which nrst supporters? Linder and chambliss? Or is it possible they were misquoted?

How about instead of being paranoid that it's all a vast taxpayer's conspiracy/deception and a grand scheme to defraud you - - just realize it's different... some people don't like change regardless.

It is intelligent to ask questions. It is foolish to make outlandish accusations.

I usually use "units" in my discussions because most of the people I talk with default to "add on" method... the type of person who says, "i didn't pay any taxes this year! I got a $250 refund!"...ie they do not understand taxes in general, much less inclusive rates like the rates used to describe payroll taxes and income taxes.

To lengthen the plank you choose to walk out on by making such outlandish statements (It's a deceitful scheme", etc...I don't know if you were the one who said that, but your posts connote same regardless)...to lengthen your plank, you not only claim that the rate is misleading and should be listed as tax exclusive but also in the very same breath that you base comparisons to the income tax and payroll tax using tax exclusive rates.

It's a silly, child-like debate method that FReepers are accustomed to. Nevertheless, the facts are being laid out there for all to see...

I hope you can come up with some real objections to this plan rather than laughable conspiracy theories. We are all interested in discussion, but not so interested in tin-foil.

[Principled]

http://thomas.loc.gov/cgi-bin/query/F?c108:1:./temp/~c10855N6Uv:e52033:
search "conform"
I don't recall it being mandatory to conform, only that there are a number of advantages to states which choose to conform... including being paid for collection services, IIRC. It says, in part
...`(c) AGREEMENT WITH CONFORMING STATES- The Secretary is authorized to enter into and shall enter into an agreement among conforming States enabling conforming States to collect...

I'll be back in a few days-

if the link has expired, go to chapter four. Nytol.

[Your Nightmare]

Which nrst supporters? Linder and chambliss? Or is it possible they were misquoted?

Um, they wrote it themselves. It was an Op-Ed article.

[Remember_Salamis]

fine, go exclusive-exclusive. a 30% sales tax is 30%. a 23% income tax is 30% exclusive. It's the same amount of money.

[ancient_geezer]

I see the word "and" between (A) and (B) not an "or". Doesn't that mean to be considered "used" a property would have to meet both of those requirement (was held on Dec 31, 2004 AND the tax has been collected).

You are reading it wrong. In the particular case "and" is meant as as a term of inclusion.

Used property is both, not "or"

A) Property on which the [NRST] has been collected,After December 31,( i.e. from January 2005, the first day the NRST goes into effect)

and

B) property that was held prior to the NRST going into effect.

You can't very well collect NRST implemented by Section 101, that does not go into effect on January 1st 2005.

B) is a grandfather clause.

Taxes were paid out of income prior to the NRST becoming effective. "Tax once but only once" is the rule of interpretation to be used by the courts and tax authorities if you look in the bill interpretation section.

But I'm glad you point that out, gives me something to pass onto AFFT that's worth looking into, and see if they can have that changed to an "OR" for clarity with the introduction of the bill in the next session of Congress.

Of course that is what committee markup is for, but why leave all the fun to Congress Critters who are generally to lazy to read bills anyway, and will mess it up if you give then any chance to at all.

[Remember_Salamis]

Again, No. the NRST is a replacement for the income tax, and that is why they're in the same terms. If you want to use ta-x exclusive terms (like sales taxes are quoted), let's start telling every american that pays a 25% tax rate thet they're really paying 33.33%. It's the same amount of money.

[ancient_geezer]

Can you show me where this is in the legislation?

Actually, I can't seem to find it.

States cannot be required to conform there sales tax systems, however it is strongly in there interests to do so under the legislation:

Refer to H.R.25 legislative text

Section 2(a)(2) CONFORMING STATE SALES TAX- The term `conforming State sales tax' means a sales tax imposed by a State that adopts the same definition of taxable property and services as adopted by this subtitle.

And at CHAPTER 4--FEDERAL AND STATE COOPERATIVE TAX ADMINISTRATION

wherever it refers to conforming state sales taxes

[Mr. K]

We are replacing the current system BECAUSE it is so difficult to understand. I did not know, for example, that current tax rates are expressed in the 'tax inclusive' terms- and I doubt very many people here know what is their tax rate (in either terminology).

So... if the intent is to simplify the tax code, why use the more complex tax rate calculation?

[Your Nightmare]

Again, No. the NRST is a replacement for the income tax, and that is why they're in the same terms.

OK, since the NRST proponents think we have use the same terms to compare the sales tax to the income/payroll tax, my effective tax rate (income and payroll) on my income last year was 19.77%. The NRST is 23%. Does that mean I'll be paying more with the NRST?

[Remember_Salamis]

not more complex, just apples and oranges.

[RockyMtnMan]

That's depends on how much you spend. How many purchases would you have to make in order to spend 19% of your income (per a 23% NRST)? If you were able to consume more than under the current income tax system and still maintain the same percentage of your income you have gained under NRST.