Continuing our look at taxes prior to the April 18^th filing deadline, we move from business tax statistics for the construction sector to individual taxes. As anyone who receives an IRS Form 1098 knows, individual tax policy is important for homeowners. And as we demonstrated in the previous post on taxes and the construction sector, individual tax rates are business tax rates for most of the home building sector.

Yesterday, President Obama proposed a long-term deficit plan that calls for a net reduction of $4 trillion in the federal government’s deficit over 12 years (note, not the usual 10 year budget window used by the CBO, JCT and OMB). The president’s proposal shares many elements with last year’s deficit commission’s recommendations. 

In general, the proposal recommends three dollars of spending cuts for every dollar of tax increase. Nonetheless, the proposal would constitute a significant tax increase, particularly if certain deficit and debt targets are not achieved after 2014.

The president formally endorsed both individual and corporate tax reform (President Obama endorsed corporate tax reform in January’s State of the Union address). The aim of such efforts would be to eliminate tax expenditures (deductions, credits, exclusions, etc) in order to lower tax rates. 

The president also recommend two specific tax proposals. First, similar to proposals that have appeared in the administration’s budget proposals in recent years, the president recommended (1) allowing the 2001/2003 tax cuts to sunset at the end of 2012 for those making more than $250,000 ($200,000 for those filing as single taxpayers); and (2) capping the value of itemized deductions for the “wealthiest 2 percent” of taxpayers (presumably taxpayers above $250,000 [$200,000 single] who constitute somewhat more than 2 percent of tax returns).

This second proposal appears similar to previous proposals that would cap the value of all Schedule A itemized deductions, including the mortgage interest and real estate tax deductions, to a 28% rate (thereby lowering its value for taxpayers facing marginal tax rates in excess of 28%). For affected taxpayers, the housing deductions (mortgage interest and real estate taxes) constitute 30% of such deductions. The proposal is estimated to raise approximately $300 billion over ten years.

More long-term, the president proposed a “Debt Failsafe trigger.” Under this structural proposal, if the federal debt is not declining after 2014 and the deficit is not less than 2.8% of GDP, then all government spending (excepting Social Security, Medicare and low-income support programs) and tax expenditures would be subject to automatic cuts. The White House factsheet also says that program cuts that exacerbate the economic downturn or impede the ability to respond to a national security emergency would also be exempt, but no additional details were provided on which programs meet this test.

The president set the end of June as a deadline for policymakers in Washington to agree to a deficit reduction framework.

What do these proposals mean for housing and individual tax policy?

First, the proposals suggest that the debate about extending the tax cuts for those making more than $250,000 has begun again, after a pause involving last December’s short-term extension of the Bush-era tax cuts.

Second, it seems clear that a debate about tax expenditures, including the mortgage interest deduction, will take place in 2011 and thereafter. For existing homeowners paying down a mortgage, as well as aspiring homebuyers, this debate is critical. For example, under the Debt Failsafe proposal, the value of the housing deductions (important for home buyers who want to estimate the after-tax cost of their morrtgage) would be subject to additional uncertainty due to the prospect of an automatic haircut due to future government debt and deficit numbers. While under the proposal these cuts would not happen until the latter half of this decade, it is reasonable to believe that they could affect housing markets today. The average mortgage lasts 7 years and the average length of homeownership is 10 years. Home buying decisions are by definition long-term decisions.

It also seems clear that a serious attempt will be made to define tax expenditures as being equivalent to government spending (as seen by the fact that both types of policies would be subject to automatic cuts under the Debt Failsafe trigger). While this linkage is accepted by many tax analysts, this notion is also controversial. Does a failure to tax equate to government spending regardless if the policy is targeted (and what tax policy is not targeted according to some factor, be it income or some other variable)? The definition of tax expenditures has always been a subjective exercise, but this classification seems to raise additional problems.

As part of this debate, certain facts about the mortgage interest deduction (MID) are important to keep in mind:

• The MID is a middle class tax policy
• 70% of the benefits go to homeowners with less than $200,000 in annual income
• The MID is worth more, as a share of household income, for the middle class
• For taxpayers earning less than $200,000, the MID is worth 1.76% of adjusted gross income on average
• For taxpayers earning more than $200,000, the MID is worth less: 1.5% of AGI
• The MID’s value is greater for younger, more recent homebuyers
• Such homebuyers are paying mostly interest in the early years of a mortgage
• As a share of household income, the deduction is worth the most for homeowners aged 18 to 35
• The MID’s value goes up for larger households and families with children
• Almost all homeowners benefit from the MID at some point during their tenure as homeowners
• 86% of mortgage interest paid in a given year is claimed as an itemize deduction (10 year average) 

More facts and statistics on the MID can be found here.

In our next tax policy post, we will look at the state of the federal governments tax receipts and the history of the top individual tax rate.