(This post is part of a series of entries examining the Deficit Commission Co-Chairs’ Proposal. For the summary post in the series, please start here.)
Wyden-Gregg Style Plan
A second proposal from the co-chairs’ discussion draft is called the Wyden-Gregg style reform, so named because it borrows concepts from a tax reform proposal that has been championed by Senators Wyden and Gregg.
Unlike their congressional proposal however, the co-chairs’ Wyden-Gregg style policy would significantly limit the housing tax rules. The mortgage interest deduction would be limited to primary residences, and then only for interest allocable to mortgage amounts totaling no more than $500,000.
One straightforward justification for the second home MID is to allow homebuyers to claim the interest deduction against two homes in a single tax year – one that they sell and one that they purchase or are construting, thereby facilitating a move. Removal of this rule could also complicate retirement plans for older homeowners, who may wish to own two homes for a number of years as they transition from one region to another. The proposal does not address what would happen in these cases. Eliminating the second home MID is unlikely to raise much revenue regardless. Many owners of second homes have sufficient wealth to portfolio shuffle assets, perhaps selling Treasury bonds to pay down a mortgage allocable to a second home that now has a relatively higher after-tax interest rate.
The Wyden-Greg style proposal would also eliminate the deduction for real estate taxes, along with the deductions for other state and local taxes. The proposal would also disallow home equity loan interest deductions.
This set of proposals would clearly be negative for homeowners and homebuyers in high-cost areas, particularly metropolitan areas. It would be particularly detrimental for younger homebuyers moving to such areas, presumably after education is completed and in search of employment, because such buyers are more dependent on debt. And it would hurt homeowners seeking to access home equity to upgrade or retrofit an existing home, an important method of improving the energy efficiency of the nation’s housing stock (51% of home equity loan withdrawals are used for home improvement purposes according to the 2009 American Housing Survey, and NAHB forecasts more than $75 billion in 2011 remodeling projects with an energy-efficient upgrade component).
The Wyden-Gregg style option would establish three individual income tax rates: 15%, 25% and 35%, but the bracket thresholds are not identified. Nonetheless, it is safe to assume that homeowners would face a higher average or effective tax rate under the plan due to the loss or reduction of many itemized deductions and the overall objective of increasing tax revenue. Small businesses, many of whom pay at the top rate (when they achieve profitability of course) would face a similar marginal rate as today. On the other hand, the corporate rate would be significantly reduced from 35% to 26%.
Tax Reform Trigger Plan
Finally, the third major option is what is called the “Tax Reform Trigger.” Under this proposal, all itemized deductions (including the mortgage interest deduction, the real estate tax deduction, other state/local tax deductions, and the charitable deduction), general business credits (such as the Low-Income Housing Tax Credit) and the employer-paid health insurance exclusion are subject to reduction pending enactment of some kind of fundamental tax reform legislation. Beginning in 2013, all such tax expenditures would take a 15% haircut (or a similar number necessary to raise tax revenue by $80 billion per year).
As noted in the press, all of these proposals are starting points for political debate. But there is a cost to housing of the debate itself. The housing market is undergoing a lengthy and painful healing process as the economy emerges from the Great Recession. A problem limiting the strength of the housing recovery is job market uncertainty, given today’s elevated unemployment rate. The existence of serious proposals to limit the housing tax provisions could unfortunately have a chilling effect on housing demand, given the long-term nature of a home purchase and the importance of debt in order to buy a large asset like a home.