.Posted on 12/21/2012 6:37:23 AM PST by Kaslin
Even though I knew some people would call me Scrooge, I wrote a few days ago about why we should get rid of the tax deduction for charitable contributions in exchange for lower tax rates.
Simply stated, I’m a big advocate of fundamental tax reform, and I would like to scrap the corrupt internal revenue code and replace it with a simple and fair flat tax.
Needless to say, that also means getting rid of tax preferences for housing. I make the case against the home mortgage interest deduction in this interview on the Fox Business Network.
Since a short TV interview doesn’t allow much time for a detailed and wonky analysis of tax policy, this is a good time to explain why tax reform doesn’t really change the tax treatment of housing. But also I’ll explain why it is a big change.
I realize that makes me sound like a politician, talking out of both sides of my mouth, but bear with me.
One of the key principles of tax reform is that there no longer should be any double taxation of income that is saved and invested. As you can see in this chart, people who live for today and immediately consume their after-tax income are basically spared any additional layers of tax. But if you save and invest your after-tax income (which is very good for future growth and necessary to boost workers’ wages), then the government tries to whack you with several additional layers of tax.
The solution is a system that taxes income only one time. And that means all saving and investment should be treated the way we currently treat individual retirement accounts. If you have a traditional IRA (or “front-ended” IRA), you get a deduction for any money you put in a retirement account, but then you pay tax on the money – including any earnings – when the money is withdrawn.
If you have a Roth IRA (or “back-ended” IRA), you pay tax on your income in the year that it is earned, but if you put the money in a retirement account, there is no additional tax on withdrawals or the subsequent earnings.
From an economic perspective, front-ended IRAs and back-ended IRAs generate the same result. Income that is saved and invested is treated the same as income that is immediately consumed. From a present-value perspective, front-ended IRAs and back-ended IRAs produce the same outcome. All that changes is the point at which the government imposes the single layer of tax.
So why am I boring you with all this arcane tax info? Because the home mortgage interest can be considered as a front-ended IRA involving more than one party. The interest paid by the homeowner is deductible, and the interest received by the mortgage company is taxable.
Under a flat tax, the system gets switched to something akin to a back-ended IRA. The homeowner no longer deducts the interest and the recipient of the interest no longer pays tax.
Some of you may be thinking that this is a good deal for financial institutions, but a ripoff for homeowners. But here are two very important points:
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In other words, homeowners or homebuyers in the new system won’t be able to deduct mortgage interest, but they’ll benefit from lower interest rates. Six of one, half dozen of another.
So why, then, is the housing lobby against the flat tax?
In part, they don’t know what they’re talking about. But what about the smart ones, the ones who understand that there’s no meaningful change in the after-tax cost of getting a mortgage in a flat tax world? Why are they opposed to tax reform.
The answer is very simple. They understand that housing isn’t directly affected by a flat tax, but they are very concerned about the indirect impact. More specifically, they understand that the flat tax eliminates all forms of double taxation in the tax code, and that would mean a level playing field.
In other words, the housing sector is now taxed rationally, and other investments are taxed punitively. Under a flat tax, by contrast, all would be taxed rationally. So the housing sector would lose its relative advantage.
So if your industry or sector is the beneficiary of a tilted playing field, then it’s understandable that you’ll be worried about tax reform even if there’s no real change in how you get taxed.
And I suspect the impact of tax reform wouldn’t be trivial.
To get an idea about the potential impact, let’s look at some academic research. Professor Dale Jorgenson of Harvard and another economist from Yonsei University in South Korea estimate that most of the economic benefit of tax reform occurs because capital shifts out of owner-occupied housing and into business investment.
…progressivity of labor income taxation is another major source of inefficiency in the U.S. tax system. This produces marginal tax rates on labor income that are far in excess of average tax rates. A high marginal tax rate results in a large wedge between the wages and salaries paid by employers and those received by households. A proportional tax on labor income would equalize marginal and average tax rates and would sharply curtail the losses in economic efficiency due to high marginal rates. An important challenge for tax reform is to eliminate the barriers to efficient capital allocation arising from ?double? taxation of assets held in the corporate sector and the exclusion of owner-occupied housing from the tax base… If both income taxes and sales taxes are replaced by a Flat Tax, and a lump sum tax is used to compensate for the revenue shortfall, the welfare gains are very substantial, $5,111.8 billion U.S. dollars of 2011 for HR and $5,444.3 billion for AS. …Our overall conclusion is that the most substantial gains from tax reform are associated with equalizing tax burdens on all assets and all sectors and eliminating the progressive taxation of labor income… We have shown that the most popular Flat Tax proposals would generate substantial welfare gains.
I don’t pay much attention to the estimates in the study about an extra $5 trillion-plus of wealth. That number is very sensitive to the structure of the model and the underlying assumptions.
But I do agree that tax reform will generate big benefits and that much of the gain will occur because there will be less tax-induced over-investment in housing and more growth-generating investment in business capital.
But as I note in the interview, that’s a good thing. It means more prosperity for the American people and a more competitive American economy.
Government shouldn’t be trying to lure us into making economically irrational decisions because of tax or regulatory interventions. Didn’t we learn anything from the Fannie Mae-Freddie Mac fiasco?
The clowns in Washington have been mucking around in the economy for decades and they keep making things worse. Perhaps, just for a change of pace, we should try free markets and small government and see what happens.
I take it you don't care about collapsing the banking system completely.
Having recently refinanced my home at a rate of 2.75%, my interest payments will be so small that the deduction is unlikely to give me any help anyway, so I no longer have a dog in this fight.
But there is a question of fundamental fairness. Just as the income which my employer pays me for services is deductible as an expense from their corporate taxes, it is taxable to me personally.
Just as the interest I pay the bank is taxable to them, so it should be deductible to me.
For that matter, working stiffs like me should be able to deduct their cost of commuting (mileage, actual car ownership costs, etc.) from their taxable income just as a contractor who, say, puts new gutters on my house can deduct the cost of bringing the truck, material and crew to the worksite. Typically, these have been handled with a standard deduction (if you are an employee) or business income deductions (if you are self-employed).
A flat tax would be a great idea if it were applied equally to the jag-offs who don't work but suckle at the government teat for a living. Even if they get an ObamaPhone, they should pay the equivalent flat tax rate on the thing. Make everybody a flat taxpayer on equal terms. Sounds great in theory, but how are you going to accomplish it politically?
Agreed! 10% - if it's good enough for the Church, it's more than good enough for the government. Anybody that thinks that's too low can voluntarily pay more of THEIR OWN money.
Your post makes me want to call you a socialist fear-monger who never likes to let a good crisis go to waste.
But I won’t.
The banking system won’t collapse just like the world will not end if we go over the fiscal cliff. Just like we didn’t need TARP.
basic food and clothing....What is that ? Cornmeal and oat meal and pork or beef or lamb? I’m just wondering. What is basic? Cotton clothing? Silk? YOU tell me. Not picking an argument. You brought it up.
What about the use of mortgage interest on a rental property as a business expense? Without that there would be less incentive to provide rental housing, and without the leverage provided by financing only the already affluent could afford to own it.
We just re-fied at 3.75%, VA assumable. One of the future benefits is that in a higher interest rate environment we can offer a buyer a better interest rate, increasing the value and desirability of the property.
That's the problem right there. Suppose a wealthy businessman makes, say, car polish. All he has to do is donate to the right politicians and presto, car polish will be classified as a tax-exempt "basic" item.
The founders were right. No income tax at all.
A sales tax at a flat rate.
Any income tax gets the government unnecessarily into your business.
If we stay with this income tax model, then I also believe that a household is a business as much as a business is, and everything required to make that business work is tax deductible.
IF it takes buildings, machines, transport, wages, etc., to make a business profitable, then it takes the same for the individual or family.
What a business considers “cost of doing business”, then it is the same for an individual.
It takes transportation, food, clothing, shelter, utilities, etc.
Anything above those reasonable expenses is “profit” and taxable.
That is, IF we stay with this income model.
Just get rid of the income tax. There's no way to really remove complication from this tax.
And you don't really mean no deductions, you mean no non-business deductions. Computing business income will always be complicated.
The only advantage of this over the FAIR tax is that the undesirable immediate regressive effect aren't so clear. Removing the deductions for employer paid benefits will cause an immediate reduction in pay for all employees, hitting the lower income folks most. It would not be fair not to do so if the self-employed can't deduct these expenses.
Removing 401K/IRA deductions will hammer the stock market, hurting pensions.
Removing deductions for insurance/annuity payments will hammer the insurance industry.
This is a nice theory, but ugly in the short run. We currently have a heavily progressive tax, made much more progressive by deductions and credits. Dumping it all at once will cause a lot of pain as folks adjust how they handle their money.
And, should we get to a flat tax, and with a firm cap at 20% or so, the government will also adjust. There are already proposals to tax you on imputed rent, the rent that you would have to pay if you rented your home. The definition of income will become very flexible, and not in your favor.
Just kill the evil income tax. The 16th amendment ratification is suspicious in the first place.
And exactly how does the home mortgage deduction (HMD) encourage home ownership? For many taxpayers, the HMD is illusory because (a) they don't itemize their taxes; or (b) as a result of the HMD, they are subject to the alternative minimum tax.
IMHO, the people who benefit the most from the HMD are the real estate brokers and mortgage lenders. They use the HMD to convince buyers to borrow more than they might otherwise borrow because the government is paying part of the cost throught the HMD. In the absence of the HMD, people will still buy houses; rather they may have to buy a slightly less expensive house than they might otherwise buy with the HMD.
A sales tax is the best way to go. If govt raises the rate it has an immediate effect on the economy and it becomes much more difficult to manipulate the public.
I really doubt we will ever see a national sales tax, except if the income tax remains in place. I think the various interest groups that benefit from the existing tax code would fight any change. Realtors will fight because of the interest deduction. Lawyers and accountants will fight because they make a good living with the existing tax code. Politicians don't want to change it because they get a lot of campaign money and power with the existing system.
Name calling without an argument is not an argument, particularly when all you offer is a hand-wave "won't happen."
All banks are required to maintain reserves. Among the principal asset reserves is their loan portfolio. Eliminate the tax shelter of the mortgage interest deduction and the asset crashes in value. At that point the banks won't be able to loan because they must raise cash. They they won't be able to raise cash because people will be paying more taxes.
At that point, sonny boy, what you get is the crash you clearly want. Don't think it would happen? Remember 1992 when GHWB forced banks to raise reserve requirements? Remember those 13% construction loans? That was nothing compared to what you propose.
There. You see, it's not that hard. To make an argument one offers a rationale with examples. You can do that, can't you?
I doubt it.
Now in principle, I don't like the mortgage interest deduction either because it builds a society on debt. I just know better than to cut off a junkie on life support without some narcane on hand. You quite clearly do not.
I agree with you. For those same reasons, we’ll never get a single flat rate income tax.
This tax code is about power as much as anything else.
As far as I know the federal government cannot direct you to purchase a house.
Next question.
I could pay off my house. It would require me to remove money from investments that are helping to create jobs, some of those workers are probably renters.
It would be no real harm to me other than affecting what I’m worth on paper, but it would hurt others.
Unintended consequences are unintended but consequences non-the-less.
You sound a little like the eat-the-rich crowd.
Time to get rid of everything in the tax code other than 9% income tax on every dollar earned. Then fire or retire 90% of the IRS and give the remaining supernumeraries work collating past records.
If there is one deduction it it will be fiddled with and added to. No deductions. At all. None. Give everyone in the country a stake in the taxes and spending. We have come to the present pass because we have eliminated half the population from the income tax. They have no incentive to resist new spending on themselves. They are not paying for it.
A consumption tax would too easily turn into a VAT. Please educate yourself as to how that works.
How about this.
Total taxes paid minus benefits received, if it is positive, you can vote twice, once as a citizen and again as a taxpayer, if it is negative, you only get to vote once as a citizen.
That gives everybody a stake in taxes and spending.
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