Skip to comments.Time to Get Rid of Tax Preferences for Housing in the Internal Revenue Code
Posted on 12/21/2012 6:37:23 AM PST by Kaslin
Even though I knew some people would call me Scrooge, I wrote a few days ago about why we should get rid of the tax deduction for charitable contributions in exchange for lower tax rates.
Simply stated, Im a big advocate of fundamental tax reform, and I would like to scrap the corrupt internal revenue code and replace it with a simple and fair flat tax.
Needless to say, that also means getting rid of tax preferences for housing. I make the case against the home mortgage interest deduction in this interview on the Fox Business Network.
Since a short TV interview doesnt allow much time for a detailed and wonky analysis of tax policy, this is a good time to explain why tax reform doesnt really change the tax treatment of housing. But also Ill explain why it is a big change.
My Edited Video
I realize that makes me sound like a politician, talking out of both sides of my mouth, but bear with me.
One of the key principles of tax reform is that there no longer should be any double taxation of income that is saved and invested. As you can see in this chart, people who live for today and immediately consume their after-tax income are basically spared any additional layers of tax. But if you save and invest your after-tax income (which is very good for future growth and necessary to boost workers wages), then the government tries to whack you with several additional layers of tax.
The solution is a system that taxes income only one time. And that means all saving and investment should be treated the way we currently treat individual retirement accounts. If you have a traditional IRA (or front-ended IRA), you get a deduction for any money you put in a retirement account, but then you pay tax on the money including any earnings when the money is withdrawn.
If you have a Roth IRA (or back-ended IRA), you pay tax on your income in the year that it is earned, but if you put the money in a retirement account, there is no additional tax on withdrawals or the subsequent earnings.
From an economic perspective, front-ended IRAs and back-ended IRAs generate the same result. Income that is saved and invested is treated the same as income that is immediately consumed. From a present-value perspective, front-ended IRAs and back-ended IRAs produce the same outcome. All that changes is the point at which the government imposes the single layer of tax.
So why am I boring you with all this arcane tax info? Because the home mortgage interest can be considered as a front-ended IRA involving more than one party. The interest paid by the homeowner is deductible, and the interest received by the mortgage company is taxable.
Under a flat tax, the system gets switched to something akin to a back-ended IRA. The homeowner no longer deducts the interest and the recipient of the interest no longer pays tax.
Some of you may be thinking that this is a good deal for financial institutions, but a ripoff for homeowners. But here are two very important points:
In other words, homeowners or homebuyers in the new system wont be able to deduct mortgage interest, but theyll benefit from lower interest rates. Six of one, half dozen of another.
So why, then, is the housing lobby against the flat tax?
In part, they dont know what theyre talking about. But what about the smart ones, the ones who understand that theres no meaningful change in the after-tax cost of getting a mortgage in a flat tax world? Why are they opposed to tax reform.
The answer is very simple. They understand that housing isnt directly affected by a flat tax, but they are very concerned about the indirect impact. More specifically, they understand that the flat tax eliminates all forms of double taxation in the tax code, and that would mean a level playing field.
In other words, the housing sector is now taxed rationally, and other investments are taxed punitively. Under a flat tax, by contrast, all would be taxed rationally. So the housing sector would lose its relative advantage.
So if your industry or sector is the beneficiary of a tilted playing field, then its understandable that youll be worried about tax reform even if theres no real change in how you get taxed.
And I suspect the impact of tax reform wouldnt be trivial.
To get an idea about the potential impact, lets look at some academic research. Professor Dale Jorgenson of Harvard and another economist from Yonsei University in South Korea estimate that most of the economic benefit of tax reform occurs because capital shifts out of owner-occupied housing and into business investment.
progressivity of labor income taxation is another major source of inefficiency in the U.S. tax system. This produces marginal tax rates on labor income that are far in excess of average tax rates. A high marginal tax rate results in a large wedge between the wages and salaries paid by employers and those received by households. A proportional tax on labor income would equalize marginal and average tax rates and would sharply curtail the losses in economic efficiency due to high marginal rates. An important challenge for tax reform is to eliminate the barriers to efficient capital allocation arising from ?double? taxation of assets held in the corporate sector and the exclusion of owner-occupied housing from the tax base If both income taxes and sales taxes are replaced by a Flat Tax, and a lump sum tax is used to compensate for the revenue shortfall, the welfare gains are very substantial, $5,111.8 billion U.S. dollars of 2011 for HR and $5,444.3 billion for AS. Our overall conclusion is that the most substantial gains from tax reform are associated with equalizing tax burdens on all assets and all sectors and eliminating the progressive taxation of labor income We have shown that the most popular Flat Tax proposals would generate substantial welfare gains.
I dont pay much attention to the estimates in the study about an extra $5 trillion-plus of wealth. That number is very sensitive to the structure of the model and the underlying assumptions.
But I do agree that tax reform will generate big benefits and that much of the gain will occur because there will be less tax-induced over-investment in housing and more growth-generating investment in business capital.
But as I note in the interview, thats a good thing. It means more prosperity for the American people and a more competitive American economy.
Government shouldnt be trying to lure us into making economically irrational decisions because of tax or regulatory interventions. Didnt we learn anything from the Fannie Mae-Freddie Mac fiasco?
The clowns in Washington have been mucking around in the economy for decades and they keep making things worse. Perhaps, just for a change of pace, we should try free markets and small government and see what happens.
Flat tax, no deductions.
Exactly. And I don’t care how many Freepers depend on that deduction - they can get off the government nipple.
Nothing will change until the majority of the Legislative Branch is thrown out. The tax code is the mother of crony capitalism, kickbacks, and economic meddling. Throw the bums out.
Gifts to charities should not be taxed with the following conditions: I would increase the charitable deductions incredibly but scrutinize the charities and people who claim the deductions themselves. Penalties for fraud regarding charity should be severe.
Government has a moral obligation to get out of the way and let people live.
Get the government out of charity and schooling
Repeal the 16th Amendment and go to the Fair Tax. That way, no need for the IRS looking at everyone’s income, and people are truly taxed on a voluntary basis.
One of the very few things that NJ does do right is that there is no tax on basic food and clothing.
Flat tax for all of the rest I agree with.
There is certainly more than enough to be taxed by eliminating those basic exceptions.
Still social engineering because then banks get a preference on mortgage loans over car loans, business loans, credit cards, etc. They already get to deduct their expenses in getting the money from savings accounts and CDs.
My preference is for a flat tax with a low rate and no deductions to remove all social engineering from the tax code. If you make more you pay more. If you want to donate money to a charity, well good for you but that is no business of the government whether you want to do it or not and whether it is a government approved charity or not. If you want to rent rather than buy, it's not the government's business.
I would like a consumption tax replacing the income tax all together even more so that most workers and consumers would never have to deal with any tax reporting again, but I see transition problems with it because it punishes the ants who earned, paid taxes and saved who would have to pay again but rewards the grasshoppers who borrowed and spent first.
"And I dont care how many Freepers depend on that deduction - they can get off the government nipple."
Concur. I have a CPA do my taxes every year because the tax system is just too damned complicated.
I disagree. Buying a single family house to house and raise your family should be encouraged. This is where good citizens originate for the building up of a good and just society.
Speculation and other real estate risk activity should no way be exempt and the burden and taxes should be on the one who takes the risk.
Question: Would a severe limitation on second and third, etc... mortgages on primary residences - especially when children are involved - help assist in innocents from being thrown out on the street when a Ralph Kramden plan goes down the tubes?
The flat tax is still a graduated income tax that penalizes success!
Tax every human living in the country the same amount each year.
Screw the poor!!
Encourage whatever you want, just don’t use the tax code to do it. The only justification for the government confiscating the fruits of my labor is to raise revenue to fund legitimate government functions. Influencing behavior of individuals or corporations is not the Feds’ business.
A short sighted opinion.
Cutting the taxbreak will be deflationary. It will further suppress home values, making the average american much poorer.
Also, deductions are not the same thing as receiving a check from the government unless you assume that every dollar belongs to the feds and any money they let you keep is a subsidy. It is our money until the government confiscates it.
In my opinion, the entire house payment should be deductable, including the principal. It would encourage accumilation of capitol and create many jobs.
XVIII and XIX didn’t help, either. At least some had the intelligence to repeal XVIII.
I’ve got no problem with ending the big three deductions: state and local taxes, mortgage interest and charitable contributions.
They make no sense to me and never did.
Agreed that it’s short sighted. Reality says we won’t be getting a flat tax system. Therefore, if we give up the mortgage deduction we will end up with higher rates AND no major deductions. Lots of homeowners (myself included) are still making payments on homes which are significantly underwater, despite having paid 20% down and having good employment. Take away the mortgage deduction, and watch another round of Americans go into short sale, foreclosure, and bankruptcy.
and why the government should be in charge of directing where and how private capital is allocated you just accept as a given?
And why is that? Because home owners are better people than renters? Because people with mortgages are more noble than those who have paid off their home?
Garbage. You are spewing the same type of liberal garbage that is spewed about us needing gun control for the “good of the children” and about us needing affirmative action to right past injustices.
I say stick it to the Americans and Freepers who depend on the mortgage deduction. Then we lower rates that much further.