How Homeowners’ Tax Rates Could Go Down, but Their Tax Bills Go Up

NAHB has published a new paper analyzing the mortgage interest deduction (MID). The MID has been in the news a lot recently, as the talk heats up of possible tax hikes in 2013 .

The new research adds to NAHB’s existing tax policy analysis by providing a means to examine the possible impacts of future comprehensive tax reform proposals. Analysis of “winners” and “losers” of tax reform requires data on an individual’s complete set of tax characteristics. In this vein, using IRS data we estimated tax profiles of typical MID beneficiaries (single, married, married filing separately, and head of household). These profiles provide average values of other major tax values, such as deductions and credits, for taxpayers benefitting from the MID.

The ability to create data-based examples  of taxpayers will offer an advocacy tool for NAHB in the 2013 tax policy debates. The data in this paper will allow us to examine any tax reform proposal with a focus on impacts on homeowners. Because most analysis of tax proposals focuses on various income classes (despite the fact that there can be winners and losers within those classes), the ability to focus on homeowners in particular will offer a different perspective.

As an example of the tax profile analysis, the paper reports that the typical single MID tax beneficiary claims a little more than $7,000 for the MID, more than $2,100 for real estate taxes paid, more than $1,900 in state income/sales taxes, and more than $600 in charitable giving deductions.

Knowing this information will allow NAHB to examine whether typical MID taxpayers are better or worse off under tax reform proposals, many of which lower statutory rates by weakening or eliminating credits or deductions. While these proposals may lower a taxpayer’s marginal tax rate, the effective tax rate (taxes paid divided by taxable income) may rise along with a taxpayer’s final tax bill. In fact, under most of these tax reform proposals debated in the last few years, homeowners would likely pay more in taxes due to scaled back deductions for housing. For this reason, the paper demonstrates that lowering tax rates in tax reform does not necessarily imply lower taxes, but rather a shifting of who pays taxes and how.

For example, suppose a tax reform proposal that cuts all itemized deductions, the standard deduction, and the personal exemptions by 75%. Further suppose the present law tax rates are replaced with a two-bracket system in which a 10% rate is applied against the first $50,000 (for married taxpayers) and a 20% rate is applied against all income above that threshold.

In the paper, we show how a typical married homeowner who benefits from the MID would have their marginal tax rate fall from 25% to 20%, but their taxable income would rise, increasing the effective tax rate from 9.93% to 13.29%, leading to a tax hike of $3,164 or nearly 34%. This hypothetical proposal is a good example of how marginal rates can fall, but taxes go up.

To illustrate how various tax items are connected, the paper walks through another example involving the housing tax deductions and the charitable giving deduction. In this case, the MID and the real estate tax deduction are hypothetically repealed. The result is a more than 23% cut for the tax benefits for the charitable deduction, despite the fact that the rules for that deduction are left unchanged. This occurs because without the housing deductions, large numbers of homeowning middle class taxpayers cease to itemize, thereby losing their charitable deduction.

The impacts of tax policy on housing can be large. Raising taxes on homebuyers means weakening housing demand, which in turn would reduce housing prices and homeowner wealth. The paper explains that at today’s valuations each additional percentage point decline in housing prices would reduce household net worth by about $160 billion. At these levels, it would take only a little more than a six percent house price decline to reduce household balance sheets by $1 trillion. With some estimates of the effect of eliminating the MID running as higher as 15%, the macroeconomic effect of any cuts to the MID are sizable, for homeowners, housing stakeholders, and the economy at large.



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0 replies

  1. Several problems with this analysis. Firs, we don’t know what the tax rates would be, or how the MID might be phased out. This is just hypothetical and may or may not happen as indicated.

    Second, this analysis is, if anything, a recommendation for higher marginal tax rates. If lower marginal rates will reduce the amount of charitable giving, shouldn’t we raise marginal rates which will also increase the value of the MID?

    Third, it looks at residential real estate in isolation. There is no question that a sudden and precipitous elimination of the MID would cause declines in home prices, but would a phased elimnation be so calamitous? And what about the effects on the rest of the economy. Wouldn’t lower marginal rates be beneficial for entrepreneurs and ultimately help the economy as a whole grow which would increase the demand for housing in the long run?

    The debate over the MID illustrates the problem of our current tax code. Every industry wants special treatment and cites myriad reasons why it deserves it. The end result is a code riddled with loopholes and needs high marginal rates so that becomes inefficent at doing what a tax code should do, raise money.

    • Thanks for the thoughtful comment. While I disagree with some of your points, I am sympathetic to your overall point that lower taxes are good for economic growth. The paper however illustrates how under some tax reform plans tax hikes may be hidden as rate cuts.

      To your first point, you are correct. The analysis is hypothetical at the moment because there are no fully fleshed out tax reform proposals. The paper provides a tool to conduct this analysis when full proposals are pushed forward.

      To you second point, the analysis is not a recommendation for higher marginal rates. It’s a call for knowing what the trade-offs are in comprehensive tax reform. Too often in the press, “low marginal rates” are confused with “lower taxes.”

      Your third point is well taken. Lower tax rates should spur economic growth, but if total taxes paid go up (i.e. the IRS collects more tax revenue each year), that’s not a tax cut. That’s a tax hike with a shifting of who pays. Compared to a tax cut with lower marginal rates, such a change in tax policy would have muted macroeconomic impacts. In fact, for many taxpayers, their marginal effective tax rate would go up, as the paper explains. I would also note that given the average homebuyer stays in their home for 10 years, a phased-in reduction of the MID would have immediate negative impacts. Homebuyers will realize that their taxes will go up in the future and change their housing demand accordingly.

      Your last point is well taken as well. I would argue however that the MID is not a loophole. It is claimed by 33 million households a year. It has been around since the establishment of income tax. It therefore does not reflect an erosion of the tax base, but rather provides parity with interest deductions for other types of investment.

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