Monday, December 06, 2010
A hard look at the mortgage-interest deduction, and why it may do more harm than good. I have argued for years that we ought to phase it out as part of a broader package of tax reforms. Of course, your results may vary.
A couple of comments, in keeping with my penchant for speaking ex cathedra from my navel:
1) Wrt the ModeledBehavior article to which you linked, The authors estimate that it each additional homeowner created by the mortgage interest deduction costs the government $53,590, a number they rightly call “staggering”. I don't agree that the MID costs the government anything. Letting the people keep their own money is a costless-to-government enterprise. If the government misses the revenue, however, let it reduce its spending by these $53.5k per "deduction."
2) That said, in re your own thoughts on tax policy (your 2005 post) I think it's suboptimal to use tax policy for social engineering; in that guise, the MID, and other deductions, should be abolished.
3) There's no good reason to keep the estate tax. It isn't the government's money, and the government has no need for it. If it misses the revenue, reduce spending. The only legitimate redistribution of wealth is the redistribution from me to my heirs, and from me to the charities I choose, not those of some faceless, unaccountable Federal bureaucrat. Once we allow forced redistribution based on personal wealth, we get Obama saying, "There comes a time when you've made enough money." How vast a fortune? Apparently, $250k is vasty enough for the liberal spendthrift.
4) I don't disagree with your idea for the basis step up on death in theory, but as a practical matter I don't think it's workable. Keeping track of basis in an environment where tax law evolves so rapidly relative to a single adult lifetime is too high a bar. The step up is a Gordian knot solution that may be the better choice. Keep in mind that, fundamentally, it isn't the government's money, so not getting it isn't an expense or any other kind of cost to the government.
5) I disagree with abolishing the corporate income tax. If corporations are to be treated as citizens in other areas of the law, let them be taxed like human citizens, too. Especially, let them be taxed at the same rates, or the same rates with an across the board discount relative to the human rates. Lose the Byzantine nature of corporate taxation. I might leave an exception to my deductions rule above to allow a deduction, if not an outright credit, for R&D, but (re)starting to allow deductions is a slippery slope.
6) Don't raise the cap on Social Security taxes at all. Privatize Social Security and Medicaid. Only liberals who want to keep Americans trapped in the liberal company town can think the government is a better investment intermediary than the private economy. The transition will be horribly expensive, but far less so than the alternative already has become.
In fairness, in 2005, something like the Obama/Pelosi/Reid clique was pretty unimaginable.
Overall, I like your tax proposals... with the exception of the corporate tax..... Because, selfishly, then I would be out of a job and would lose my house and have to declare bankruptcy..... However, I think that lowering the corporate tax rate to say, 12.5% would be reasonable......
You can make similar arguments about the tax break for employer-provided health insurance. We'd have a smaller health care sector, but for.
Politically, I'd expect it'd be harder still to do away with the mortgage interest deduction because it's already been capitalized in current home values. There's also regional variance to this effect: it's stronger in high wage / high tax states like California, New York, New Jersey, etc.
We may have a window to get this done, however, if and when the entire residential real estate market deflates despite Ben Bernanke's efforts to the contrary.
Meanwhile, I've got my eye on the current "compromise" being worked on re: extending the Bush tax cuts. It could be a tell on how much spine the Republican Congress has. If they can't work any spending cuts into this "compromise" it doesn't bode well for their ability to address bigger changes in 2011. E.g, I had hoped that killing Harry Reid's LA to Vegas speed rail would have been included in the mix as a means to pay for extending unemployment insurance. Silly Rabbit me ! Developing.
Beyond “lost revenue” there is a far more damaging cost to the interest deduction, and that is distortion of behavior.
We get all sorts of bizarre behavior from corporations because we tax equity capital but not debt capital–excess leverage, sham transactions like sale-leasebacks, so-called “trust preferred” and so on.
Likewise, for individualts, we distort incentives towards buying excessively large/expensive homes, creating housing-based debt in place of other borrowings, and disadvantaging renters versus other taxpayers.
E. Hines correct about the privilege corporations enjoy – a limited privilege of limited liability, which permits capital efficiency in a way not otherwise possible. The right price for that privilege is greater shareholder control of their property, and a dis-entitling of entrenched, and often-self-serving managers.
But E. Hines is mistaken about the corporate tax. Corporations do not pay taxes. Corporations are merely disguised tax collectors for government. And there too there is a distortion; government can hide behind the corporate veil and individuals don’t get to see just how much government is extracting from them. Make it explicit. Even better, abolish withholding and have every individual taxpayer write the check. Imagine how THAT will focus attention.
The 53k is the scariest way they could find to represent their results. It's the total annual tax "cost" to government of all mortgage interest deductions divided by the increased number of new homeowners who are influenced yearly to buy due to the deduction.
That was per one of their data sets. Other calculations showed a net decrease in homebuying decisions due to the deduction, mainly due to its upward effect on price in high density metropolitan areas.
They started with a hypothesis then went on to prove it with a study riddled with assumptions, implications, and "mays".
Of course their data collection ended in 2007, before the housing crash, so the whole thing could go into the trash pending more up to date numbers.
One more thing, they don't seem to have considered that the standard deduction is based in part on an assumption of total housing costs, including mortgage interest, and should rightly be adjusted downward if the mortgage interest deduction is eliminated.
For heaven's sake make the tax code consistent and simple. Eliminate virtually all deductions. Cut income tax to either a flat rate...or add a VAT tax, the deductability of which on one's income tax is progressive (to eliminate the effect of the VAT on low income citizens).
Make it EXTREMELY difficult to change tax law. ...along the lines of a Constitutional amendment.
Be sure everybody pays something...just to keep their interest in the game.
Of course, the harsh truth is that we really don't have a tx problem...we have a spending problem.
"The emerging agreement also includes tax breaks for businesses that the president said would contribute to the economy's recovery from the worst recession in eight decades.
Off-topic Mr. Tigerhawk, but the MSM keeps trying to make this recession seem worse than the one in the early 80s in an attempt to blind the public to the effectiveness of Reaganomics. Would you do a post on this?