28.2.09

BROADENING THE TAX BASE. President Obama's economists propose to change the way high-bracket filers calculate deductions.

The Obama administration hopes to tap the rich to help pay for its ambitious programs. Specifically, that would include slashing mortgage interest deductions for high-income taxpayers.

The proposal would cap at 28% the tax break for itemized deductions.

That would leave people in higher marginal tax brackets of 33% and 35% - the wealthiest Americans - with a smaller benefit from the deduction of mortgage interest, state and local taxes and other items such as charitable contributions.

The move is projected to raise $318 billion over 10 years and fits nicely with the president's campaign pledge to increase taxes only for families earning more than $250,000. Few, if any middle-income homeowners are in tax brackets of more than 28%.

On the one hand, the proposal taxes on the basis of ability to pay, and at least one observer sees horizontal equity at work.

Dean Baker, co-director of the Center for Economic and Policy Research, a D.C. think tank, said he was impressed with this part of the budget plan.

"It's a no-brainer for economists," he said. "Why have taxpayers been [in effect] subsidizing home payments for the highest income people in the country?"

The overwhelming majority of low and middle income people take the standardized deduction when they file their taxes [and] they receive no benefit at all from the mortgage interest deduction, said Patrick Fleenor, chief economist for the Tax Foundation.

"If you live in an inexpensive home or you're deep in your mortgage and paying little interest, you're better off taking the standard deduction," he said.

On the other hand, there are substitution effects.

Housing industry sources were disheartened by the news, saying it would put downward pressure on home prices.

"The timing couldn't be worse," said Lawrence Yun, chief economist for the National Association of Realtors.

"With the housing market still reeling from its worst downturn since the Great Depression, this is not the time to talk about raising taxes on home buyers and home owners," said Joe Robson, president of the National Association of Homebuilders, in a statement.

The plan, which wouldn't start for another two years, is intended to focus solely on high-income Americans, but its impact would be much broader, say industry sources.

Yun said it would reduce the value of high-end homes by increasing ownership costs. Potential homebuyers calculate affordability as a total outlay of funds. If the tax deduction goes down, their ownership costs rise.

But the bailout protests got their start with a newsie worked up about taxpayers covering for the overspent individual with a four-bathroom house. (That might be this era's version of the steaks paid for with food stamps.) I'll bet there are plenty of foreclosed and unsold trophy houses on the market for which the current lower price more than offsets any lost tax benefit.

For example, someone in the 35% marginal rate bracket buying a million dollar home and putting 20% down would have an $800,000 mortgage. At 6% interest, they'd be paying interest of $48,000 a year, or $4,000 of their $4,797 a month mortgage payment.

Currently, 35% of that payment - $16,800 - is tax savings, but under the new plan, only $13,440 would be, a $3,360 difference.

With a self-amortizer that difference diminishes as time passes. A lower purchase price also lowers the interest payment. Do the math. And bear in mind that builders might be quite happy to build those same houses for lower prices rather than be doing nothing at all.

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