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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
I’m not sure the businesses shouldn’t be taxed on gross income. Why should they contribute less simply because they’re less efficient?
That particular form of business know as a corporation, however, is fictitious. It stands in for a group of real people (namely its shareholders). Taxes paid by corporations should be understood to be paid on behalf of their shareholders. Double taxation occurs when income for which the corporation has already been paid on behalf its shareholders is taxed again when distributed to its shareholder (dividends) or realized by the sale of shares (some part of capital gains).
Say that your legitimate expenses are more than your gross income. In other words, you lost money that year because sales are down, but you still had to pay your employees, and keep the lights on. Are you sure that it’s realistic to tax based on your gross income?
Say that I as a citizen have legitimate expenses that are more than my gross income. In other words, I lost money that year because I was laid off but I still had to pay for my food and keep my lights on. (And thus I was living on savings and debt.) *I* still have to pay taxes based on my gross income. (In point of fact, that was 2008 for my husband and I, and we only managed to pay off that tax bill a couple months ago.)
If it’s unfair to tax on gross income for companies regardless of their profitability, why isn’t it unfair to tax households on the same basis?
The short answer is that it is unfair, but that’s not a reason to treat everyone unfairly. In principle, money you spent to generate income is considered money you never saw. If you sell paintings, you should be able to deduct the costs of paint, canvas, etc. For corporations, which are pure profit-making enterprises, all expenses are presumed to be income-generating. For individuals, however, it is much tougher to create clear rules about what’s income generating vs. consumption.
To address this problem, income tax systems have exclusions on the first $x of income, and then further allow for deductions on income-generating expenses. It’s unjust, IMO, that these deductions have been scaled back so much in the US. Unfortunately, the more Congress and the IRS attempt to close “loopholes”, the more they undermine sound tax principles, and the more individuals get unfairly snagged. But that’s an argument for more deductibility of expenses, not less. To be clear, you pay taxes on your net income, but what the IRS allows you to deduct as expenses is highly circumscribed.
I also would like to see all of the tinkering with incentives and disincentives go away. Unfortunately this proposal as presented here has nothing to do with that. It would eliminate a popular deduction without any compensating overall simplification of the tax code or reduction in the tax burden. If it was part of an overall reform that reduced rates and simplified the system (such as a flat tax with no deductions), I’d be all for it.
Here is my result. Did the taxes yesterday, and in the year that I paid off my (admittedly small) mortgage, we ended up with a small refund. That was due to the fact that Hubby bought his childhood home in a crumbling inner city on the East Coast (before it was sold for back taxes), and he paid property taxes that we were able to deduct. Now we both are homeowners in our own right, mortgage-free.
This is a hard case. The mortgage interest deduction is crazy in terms of the incentives that it lets loose in the market, not least of which is the phenomenon of house flipping. (as an aside, while peering over at the shows that my wife watches on HGTV, I could never figure out why stainless steel appliances were so important to house buyers, until I realized that if they’re already there, they are in the tax deductible bucket, while if they are not, you pay full pop). So, it is highly desirable to phase them out from a policy point of view.
However, for the reasons that Mr Stuttaford highlights, they are also not easy to remove at this point due to the politics. The ideal might have been to tinker with them at the edges during the real estate bubble. Would have been easier to do in that market- reduce house price inflation while limiting the side effects in the rest of economy from trying to do that through interest rates alone.
At this point, it’s probably too late, at least until the next housing bubble.
It seems fundamentally unfair that renters should subsidize purchasers.
I meant it when I said I wasn’t sure. In your scenario, the business still has to pay property and sales taxes. Why would income taxes be different? If you want to keep the business going, you have to put in more capital–just like you have to pay your employees.
The real question is why tax income at all? Depending on the answer, it may lead you to net income or to gross income.
The simple solution, which hits the third vacation homes and high-cost-regulated-real-estate crowd but leaves the average flyover types alone, is to allow the deduction up to the national median home value rate, then rapidly phase it out, with no allowance for second homes. Including Congresspersons who want to wrote off both their plain district houses and their Chevy Chase Colonials.
This is really the least worst of the tax code variants to the flat tax, which will never exist regardless of our wishes that it were so.