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A Tax ‘Reform’ For The Worse — Andrew Stuttaford
Over at the Washington Examiner, Philip Klein argues in favor of phasing out the mortgage interest tax deduction, an idea that seems to be gaining some traction with the likes of Republicans, such as House Ways and Means Chairman Rep. David Camp. It shouldn’t have.
Phasing out this deduction may, at least to market fundamentalists, rest on sound economic logic, but politically there is very little to be said for it. Before we get to why, let’s remember a few things:
Yes, as Mr. Klein notes, the deduction is ‘expensive’, but, despite it, the amount of tax imposed on property in the US (expressed as a percentage of GDP, 3.0% in 2012) is already at the higher end of the OECD range. Let’s also note that, expressed again as percentage of GDP, the taxation of personal income (I am unclear whether this is includes state and city taxes) in the US stands out as neither particularly high nor particularly low. In 2012, it was equivalent to 9% of GDP, compared with Germany’s 9.6% and France’s 8.2%.
Those income state data do not disclose how that income tax burden is shared. Well, fear not, redistributionists — the US already has one of the most progressive tax systems in the world. Scrapping the mortgage interest deduction will make it even more so. That might be fine in the eyes of people on the left, but those folks should be left to get on with their dirty work without a helping hand from the likes of Rep. Camp.
And then there is the matter of simple political reality. Mr. Klein’s preferred approach to the deduction is “to slowly phase it out over time as part of a broader tax reform that lowered tax rates for everybody.” That’s not illogical, but it is naïve. The mortgage tax break is one spot of relief from the IRS that has, up to now and for the most part, been politically untouchable. To swap that for a reduction in rates that could be all too easily reversed would (in the absence of structural tax reform of a type that is not, sadly, going to take place) be madness.
The mortgage interest tax deduction should stay.
Published in General
Generally speaking, I want all the tinkering with incentives and disincentives to go as far as away as possible. I’m tired of the machinations of Congress, trying to guide me to places they think I should go. In no small part, it’s that same social engineering that brought about the housing bubble – by encouraging behaviors that might not have taken place absent the encouragement. Meaning incentivizing high-risk loan-making is never going to end well. And it didn’t.
But as a relatively new homeowner, I think the interest deduction is a swell idea. It may “cost” the USG revenues, but that’s always a good thing, in my book – less money to spend means less money to spend.
The one thing about the deduction is that the rational adult does not factor that deduction (much) into their homebuying decision. That owning a home will reduce the income tax bite also does not alleviate the fact that property taxes will be paid on the new home, and it’s likely that those two things result in a wash.
There’s a lot to be said for a simple tax on income only.
Of course it should go. There’s no more reason for home loan interest to be deductible than car loan interest. A change in rules causes collateral damage though, when people have planned and chosen according to the rules that exist now. Pretty cruel to tell somebody who just took out a thirty year mortgage that the tax break they counted on will be disappearing. Homes would drop in value- lots of losers from that. The economic benefit of the deduction was long ago absorbed in inflated sizes and prices of homes and working that off in a stagnant economy would be unpleasant.
As far as the mortgage tax deduction being an anti-redistributionist tactic, note that it does not protect the affluent who bought a modest home and/or paid off their mortgage. In fact it encourages people to borrow more and put down less on a home.
Sorry to be dense, but I don’t entirely get how removing the mortgage deduction makes the code more progressive. Which actually means I don’t get what you’re saying at all. Seems like it would just smooth out a kink in the middle of the curve. Even if the question concerned the idiotic exemption of interest on state and local debt, eliminating it would do nothing to increase progressivity that I can see.
The main political difficulty is from banks and brokers (of all sorts), not affected homeowners– who might just be delighted to end the shell game and stop having the tax code tell them how to order their lives. There is a lot to be said for a simple income tax code, including that it would give the governed and the governing a better idea of what’s actually happening.
I paid off my mortgage last October. We’ll see what effect that has on our taxes when I do them tomorrow. Stay tuned.
Congratulations! No small feat, that.
The home interest deduction was established by the word “income” when the tax was passed in 1910’s. Income was something you received from capital, such as rents, dividends, and interest. Ordinary wages were not considered income, and only taxed later to help with wartime needs. As such, when paying interest on your home, the bank (or capital holder) would pay the tax, and you would get a “credit” against your income from rents, dividends, and interest. Like health insurance after WWII, the interest deduction was kept to help offset the costs of building homes for the returning veterans.
“Tax Reform”
If “tax reform” means
then yes let’s move forward with all due haste.
If “tax reform” mean let’s start by jacking up taxes on the little guy, then we have no common ground.
In principle, I am against social manipulation through taxes, but first we need to spend less than we take in as income. THEN we can start eliminating tax breaks for normal folks as we continue cutting taxes.
This post exemplifies much of what is wrong in the thinking about tax reform. Property taxes are too high, so the logical response is to make mortgage interest deductible? Never address a problem directly when you can work around it in through the tax code. Too bad the deduction doesn’t help people without mortgages, who still pay high property taxes.
If the inability to enforce a trade in perpetuity is grounds for refusing to make the tax code more sensible, then reform is impossible. We’ll just have to coast down the slippery slope until the next fiscal crisis, when we’ll lose the deduction and receive nothing in return.
Sorry, but lots of people would be better off renting and our economy would ultimately be more stable for it. The less effort spent defending irrational tax policies, the more clearly we can address why progressive taxation is the opposite of “social justice.”
There used to be what were quaintly called “principles of taxation”. The two most basic were (a) no dollar of income should be taxed twice; and (b) a person shouldn’t be taxed on money he or she never saw.
Originally, ALL interest payments were deductible, in accordance with principle (a), because interest income was taxable. Taxing both interest paid and received would be comparable to levying sales tax against both the buyer and the seller. However, the interest paid deduction was viewed as a “break” that was done away with in the 1986 tax reform — except for mortgage interest. It’s an injustice, IMO, that car interest payments and personal loans are not similarly deductible.
Another “break” that is often mentioned is the state income tax deduction. But that’s just an application of principle (b). You shouldn’t be paying taxes on money that you never saw because you paid it out in taxes.
Flat tax. No deductions. Problem solved.
We need to clean the whole thing out.
The tax code cannot be objectively and clearly understood.
All of these fiddles just make everyone a potential criminal.
Flat Tax. And no corporate income tax at all (big companies don’t pay taxes anyway).
In the eighties I was in the 48% tax bracket. The only reason I bought a house was the tax deduction. I really didn’t plan to live there long enough to justify buying a house. I should have rented. The housing market collapsed (Anchorage), and that house depreciated over $1000 very month I lived in it.
I am in favor of eliminating ALL deductions. Give me a simple tax code.
How about this point:
Just think of the effective tax break we could give everyone by simply streamlining the tax code. There are a hundred thousand companies with revenues of nine billion dollars a year, all spent to help people fiddle with these stupid little deductions that make so much sense politically.
We could pump nine billion dollars per year into our economy without actually cutting taxes, just by creating a tax system that didn’t require professionals to make sure the taxes were paid. What’s a measly little interest deductions for that?
If the proposals on the table were to eliminate the deduction as a move to a flat tax, that would be an improvement. But the proposals on the table amount to eliminating the deduction in order to fund tax reductions elsewhere. It’s a backdoor redistribution, not based on any sound principles of taxation, but an attempt to juice some section of the economy by rejiggering incentives. A flat tax would get away from the idea that the tax code should be used to influence behavior. But eliminating the deduction on its own would only reinforce the idea that that tax code should be a tool for social tinkering.
There was no “Mortgage” interest deduction until 1987. Prior to that, ALL interest, mortgage and otherwise, was deductible.
Fair Tax. Do it all on End point consumption.
I don’t see that taxing interest expense is double taxation of the same money in a way different from other expenses. If I hire someone to paint a portrait of my dog, I pay for it with money that has already been taxed, but it is also taxable income to the artist. Interest income is likewise incurred as a choice on the part of the spender.
This is best comments so far. According to these principles, there are two choices:
1) Restore the deductions for all interest paid.
2) Eliminate all taxes on interest income and remove all interest deductions
The first choice favors private debt and consumption, the second choice favors private savings.
Stuttaford’s argument is pragmatic in nature, not idealistic. He’s probably right pragmatically, but I too resent the deduction. I simply prefer to rent, not being disposed towards maintaining a house and all that it entails.
Why should I subsidize those who do (or worse think they do, but fail because they really aren’t)?
I’m sorry as a renter I don’t see why I should support all this pandering to homeowners. The whole owning a home as the path to prosperity is the kind of nonsense that got us into this housing mess to begin with. I say you can keep your mortgage deduction when I can deduct my rent payments (heck even deducting part of my rent would save me a ton yearly).
After being really, really motivated to buy my first home a few years ago, I now pine, nostalgically, for renting. Even with the deduction for interest, I’m paying probably 50% more for the privilege of “ownership”, which is really just a way of saying a bank agreed to loan me money at a rate and payback period that almost guarantees a near-tripling of their investment.
I should become a bank.
In Vermont, there’s a Renter’s Rebate, which is some kind of attempt to provide the same slight relief that mortgage owners “enjoy”.
In other words, it’s more of the same. You have a system that’s inherently unequal, make it more complicated, and actually create a policy that negates the effect of the original policy, to some degree.
For what I’m paying for my 2-bedroom condo, with the mortgage, property tax escrow, and monthly maintenance fees, I could be renting a house, with a view, 2-car garage, and many fewer headaches.
Why did I bite this off again? Oh, that’s right – so later on when I buy a final home it won’t be my first.
Agreed.
I think it was Thomas Sowell I was listening to about this and how they got cause and effect mixed up.
Oh, homeowners are well to do, have intact families, high education, and high level of civic involvement?
Well, then we should make sure everyone has a house so that they will begin to exhibit these virtues.
Or, maybe they were wrong and these people were homeowners BECAUSE of the other factors.
I think you stated the principles right, but I don’t think your application is correct.
I don’t think taxing interest is double taxation (unlike the situation with corporate income and dividends/capital gains). In the case of taxing interest, income is earned by one party, taxed as income, and then used to pay a third party for services rendered (the cost of borrowing money). You also used after tax earnings to pay your dry cleaner and your chiropractor, but they still report that money as taxable income. The difference with corporate income and cap gains/dividends, is that a company IS it’s shareholders, the money wasn’t “earned” a second time.
I don’t think state and local governments taxes fall under principle B. I can see the case for charitable contributions though, because you aren’t getting goods or services in return. Like it or not, we are supposedly getting something for our state and local tax money. Taxes are effectively a bill for services rendered by government to the community. You may think some of them are wasteful and not worth the money being spent, or just plain redistribution, but letting people deduct state and local taxes effectively subsidizes tax payers in high tax jurisdictions at the expense of those who live in lower tax states and communities.
Regardless of the effect of subsidizing high-tax jurisdictions, the principle holds. Otherwise, you could end up in a (theoretical) situation where state taxes are 50%, federal taxes are 50%, and the taxpayer is left with nothing. Around the globe, this deduction is standard, as it’s been here.
Interest payments are more of a grey zone. Businesses can deduct all interest paid. Individuals can’t itemize all their expenses, but this is one they clearly identify. I can see a case for identifying it as a consumption expense, but I think it’s also reasonable to treat it as an income-generating expense, like child care expenses (e.g., houses generate rent, either realized or imputed). Please note that there are other countries that allow deductibility of some or all interest paid, on the basis of this principle.
My preferred approach, FWIW, would be to eliminate the deduction for interest paid, but remove taxes on interest earned, as Z of MT proposed in #19.
BTW, in #26 I mention other jurisdictions not to say we should follow the crowd. Rather, I mention it as evidence that there was a time when the principles of taxation — not the behavioral or redistributional effects of taxation — were what policymakers considered, and there was substantial agreement around the globe as to what these principles are and how they should be applied.
The income tax, as it is, needs to be replaced with a consumption tax anyway. Otherwise, the robots are going to replace the workers and the robots will be imported from someplace with better liability shielding and lower income taxes. Might as well start making plans now.
Every person’s expenditure is another person’s income. No one is taxed for “paying interest.” Interest is paid from income earned (most often by other means), and that income is taxed just like all other income. There is no difference in principle between spending money to compensate for the use of another’s money (interest) and spending money to compensate for the use of another’s time (fees) or any other good.
If it were that simple, then all spending would have to be treated equally, and businesses would pay taxes on their gross revenues rather than their net income.