Posted on 04/23/2004 4:39:23 AM PDT by Remember_Salamis
A $5,OOO Cat? The NRST and Real Estate
By Steve Hayes President, Citizens for an Alternative Tax System
Once Johnny came home with a puppy that he had found at the park. His father told Johnny that he couldn't keep the dog. Johnny protested but his father was unrelenting.
Tearfully, Johnny agreed. He took the puppy and left and was gone about an hour. When Johnny returned his father asked what became of the puppy. Johnny said that he sold it for $10,000.
The father demanded an explanation. Johnny said that he had gone to the neighbor's home and sold the puppy for two $5,000 cats.
Many in Washington explain everything that they do for us in glowing terms. They refer to the great benefits reserved for us in the tax code.
However, often when we examine the manna from Washington we find that the supposed benefit isn’t as good as we were promised. The benefit from Washington all too often really resembles one of the boy's $5,000 cats.
An example of this is the mortgage interest deduction. The fact that this benefit will be repealed by the national retail sales tax ("NRST") is one of the major objections used by opponents of the NRST.
Is the mortgage interest deduction really a "great" benefit or a $5,000 cat? The mortgage interest deduction is a provision in the federal income tax code which permits the deduction of the amount of mortgage interest paid on your home mortgage from taxable income, the amount of income on which federal income taxes are calculated.
Washington bureaucrats and realtors trumpet the tax advantages that accompany home purchases. "Buy a home and get a 'tax shelter' like the 'big guys' ". Alas, the "mortgage interest tax shelter" is, for many Americans, a $5,000 cat.
Here is an illustration of the home mortgage deduction. Fred and Joan Jones have two children and an annual income of $60,000. On January 1st, they buy a home a home for $140,000, pay $14,000 down and obtain a $126,000 30-year mortgage at 7 percent interest. The monthly mortgage payments are $838. Fred and Joan will pay mortgage payments of $10,059 in year one. Of the $10,059, $8,780 is interest and $1,279 is principal, which under the present federal income tax is not deductible. {1}
At the end of the year, eager to take advantage of this great "tax shelter, the Jones family deducts the mortgage interest paid of $8,780 from its taxable income of $60,000 and $10,600 of personal exemptions {2} leaving a new taxable income of $40,620. By deducting the $8,780 of mortgage interest the Jones family will pay $6,094 in federal income tax. {3}
At first glance, this would seem to be a real benefit. Fred and Joan were able to reduce their taxable income by the amount of the mortgage interest they paid. They know that their top marginal federal income tax rate is 15% so they appear to have received 15% of $8,780, or $1317, of the money that they would have paid in federal income taxes back from the government. However, in order to utilize the "mortgage interest tax shelter", they must file a 1040 return and itemize deductions. Interestingly, most real estate agents don't explain this fact but, without itemizing, the Jones family would have been able to take what is called the standard deduction that is available to everyone whether they pay mortgage interest or not.
"65,400,000 Americans are home owners but only 29,396,016 Americans take the mortgage interest deduction. For many of these 29,396,016 Americans the benefits of the mortgage interest deduction are marginal and more illusory than real."
If they had not deducted the $8,780 in mortgage interest payments but simply taken the standard deduction, Fred and Joan would have paid $6,551 in federal income taxes. This means that the mortgage deduction actually only saved them $457 in federal income taxes over what they would have paid if there was no mortgage deduction. On top of this, filing a return and taking the standard deduction generally means that you are less attractive to the IRS for an audit. So, the Jones family filed a more complicated return and increased their odds of an IRS audit to save $457. {4}
Another point that needs to be understood is the idea of "after tax expenditures." These are expenditures which, unlike the mortgage interest deduction, are not subtracted from our taxable income when computing taxes. These are items for which we have to earn enough to enable us to pay the income tax and still retain the net amount to be spent. Since the Jones family is in the 15% marginal tax bracket, in order to have a dollar to spend they will have to earn $1.18 and pay 18¢ in federal income tax (15% of $1.18) to net $1.00. As stated earlier, $1,279 of the total mortgage payments in year one is principal which is not deductible. The $1,279 of principal payments in year one is paid from the money that Fred and Joan have after payment of their taxes. To Fred and Joan, this means that they had to earn $1,505, pay $226 in federal income taxes (their marginal income tax rate is 15%) in order to net $1,279, the amount they paid in principal on their mortgage.
To recap, Fred and Joan have earned $60,000 and the examples shown in figure 1 illustrate the actual benefits they received from the mortgage interest deduction.
With Mortgage Deduction Without Mortgage Deduction
$60,000 $60,000
- 4,590 FICA {5} - 4,590 FICA
- 6,094 Federal Income Tax - 6,551 Federal Income Tax
- 10,059 Mortgage Payment - 10,059 Mortgage Payment
$39,257 Net Amount Remaining $38,800 Net Amount Remaining
Figure 1.
Assuming their income goes up at 3% per year, in 5 years they will be making $67,531 but will only be saving $406 more than they would be saving if they utilized the standard deduction. {6}
The amount of income tax savings is decreasing because the amount of interest is less each year and the amount of principal increases each year. The amount of mortgage interest paid in the fifth year will be $8,367 and the amount of principal will be $1,692.
The Jones family cash flow will then be:
$67,531 - 5,166 FICA {7} - 8,245 Federal Income Tax - 10,059 Mortgage Payment $44,061 Net Amount Remaining
However, if Fred and Joan want to actually own their home they will see a rapidly decreasing benefit from the mortgage interest deduction as they pay down the loan. In fact, by the 14th year, it will be better for Fred and Joan to take the standard deduction of $6,900 rather than the standard deduction of $6,900 rather than the mortgage interest deduction of $6,888. {8} Moreover, if Fred and Joan had purchased a home with a mortgage of $99,000 instead of $126,000, they would have saved nothing from the mortgage interest deduction.
This is one of the primary reasons that 65,400,000 Americans are home owners {9} but only 29,396,016 Americans take the mortgage interest deduction.{10} For many of these 29,396,016 Americans the benefits of the mortgage interest deduction are, like for Fred and Joan, marginal and more illusory than real.
If they actually pay the mortgage on their $140,000 home, Fred and Joan will have paid $175,781 in interest and $126,000 in after-tax principal for which they would have had to earn $148,000 and pay $22,000 of federal income taxes to net $126,000.
Contrast the above scenario with the situation if Fred and Joan purchased their home after the passage of the NRST using the same purchase price and 30-year mortgage at 7% interest.
Fred and Joan will receive their income without any income tax withholding. They, not the bureaucrats in Washington, will decide how much income tax they pay by how much they elect to spend on retail purchases. No longer are Fred and Joan treated as children or mentally deficient adults but as adults capable of making their own decisions.
Fred and Joan receive $58,234 in income, which is the earnings of $60,000 reduced by $4,590, the amount of the FICA withheld and increased by $2,824, the amount of the NRST rebate {11} to a family of four. Like under the federal income tax, the NRST will tax the principal of the house purchased by Fred and Joan. Under H.R. 2001, the bill introduced by Congressmen Dan Schaefer (R-CO) and Billy Tauzin (R-LA) that replaces the income tax and the IRS with an NRST collected by the states, the $140,000 purchase price of the house will be taxed by the NRST, resulting in a tax owed of $24,706. This tax can be paid either at the time the house is purchased or over a 30-year period. If the election is made to pay the $24,706 over 30 years then Fred and Joan will pay $73 per month or $876 per year.
The $8,780 of mortgage interest will not be subject to the NRST. {12} At the end of year one we see the results shown in figure 2.
NRST Federal Income Tax
$60,000 $60,000
- 4,590 FICA - 4,590 FICA
- 876 NRST Payment on the Principal - 10,059 Mortgage Payment
- 10,059 Mortgage Payment $44,991 Net Amount before Income Tax
+ 2,824 NRST Rebate - 6,094 Federal Taxes
$47,299 Net Amount before NRST --
- 6,345 Estimated NRST {13} --
$40,954 Net Amount Remaining $39,257 Net Amount Remaining
Figure 2.
After 5 years under the NRST, and assuming a 3% increase in their income, Fred and Joan would have the following net amounts of money under the NRST and the present income tax as shown in figure 3.
NRST Federal Income Tax
$67,531 $67,531
- 5,166 FICA - 5,166 FICA
- 876 NRST Payment on Principal - 10,059 Mortgage Payment
- 10,059 Mortgage Payment $52,306 Net Amount before Income Tax
+ 2,824 NRST Rebate - 8,245 Federal Income Tax
$54,254 Net Amount Remaining --
- 7,388 Estimated NRST {14} --
$46,866 Net Amount Remaining $44,061 Net Amount Remaining
Figure 3.
Now, we have assumed that the interest rate to be paid by Fred and Joan would be the same under the present income tax and the NRST.
This is really not the case. Economists agree that interest rates under the NRST will decline by at least as much as the difference between the municipal bond rate and the standard, non-tax free bonds. Some believe that the reduction will be much greater as America becomes the greatest place for investment and funds flood into the United States from all around the world. However, if we just assume the smaller reduction this will mean that the mortgage rate will be not 7% but 5.5%. {15}
This would mean that the mortgage payments and total cost of the mortgage for Fred and Joan would be reduced. Below are comparisons of the present income tax and the NRST with the lower interest rate. Here is a recap of the new costs and the comparison shown in figure 4.
NRST Federal Income Tax
$60,000 $60,000
- 4,590 FICA - 4,590 FICA
- 876 NRST Payment on the Principal - 10,059 Mortgage Payment
- 8,585 Mortgage Payments $45,351 Net Amount before Income Tax
+ 2,824 Rebate - 6,094 Federal Income Tax
$48,773 Net Remaining before NRST --
- 6,166 Estimated NRST {16} --
$42,607 Net Amount Remaining $39,257 Net Amount Remaining
Figure 4.
This means that the total cost of paying off the mortgage under the NRST is $131,548 of interest, $126,000 of principal and $24,705 NRST tax for a total of $282,253. Contrast this to $323,781, the amount that would have to be earned and spent under the federal income tax, a difference of
$41,258.
Yet another factor we have not addressed is that under the NRST, it will be much easier for Fred and Joan to save the money needed to purchase their home. Under the present income tax in order for Fred and Joan to save the $10,000 that they need for the down payment on their home, they will have to earn $11,765 and pay income taxes of $1,765 to net $10,000. If they deposit the money in a savings account then the interest will also be taxable.
However, under the NRST, Fred and Joan will only have to earn $10,000 and save that amount because earnings are not taxable under the NRST. Any interest earned on a savings or investment will not be taxed under the NRST. The NRST gives Fred and Joan the ability to keep all the money that they don't spend whether the source is earnings or a return on their savings and investment.
There are a number of other things that we have not taken into account when we do our comparison. The foremost of these is that the economic studies that have been done on the affect on the rate of growth in the economy after the enactment of the NRST all show increased rates of growth and increased rates of productivity. This is very important because increases in income are derived from increases in productivity.
What does the increased economic growth mean to each of us? If the economy had grown at the same rate since 1973 as it did prior to 1973, the average family would have an additional $10,000 per year in disposable income.
It is time for Americans to quit accepting $5,000 cats and demand a tax system that really works for America, the NRST.
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FOOTNOTES
{1} This is omitting the cost of any private mortgage insurance.
{2} Each family member receives a $2650 personal exemption or $10,600 for a family of four.
{3} For purposes of our example we are not considering any deductions that might be available would increase the amount of itemized deductions because these vary widely among taxpayers.
{4} The $457 in savings would be increased if there were additional itemized deductions like real estate taxes, state income taxes and charitable donations. For example, if Fred and Joan had an additional $1000 of deductions then they would have saved an additional $150 in their 15% income tax bracket.
{5} Federal Insurance Contributions Act
{6} This actual savings from the mortgage deduction will likely be less because the standard deduction will also have been increased.
{7} This assumes that the FICA will be assessed on $67,531.
{8} Again, this is assuming that the standard deduction for a family--of four remains at $6,900 which it will not. Therefore, the standard deduction will likely exceed the mortgage interest several years earlier.
{9} U.S. Census Bureau
{10} Statistics of Income Bulletin, published by the Internal Revenue Service
{11} The NRST rebate is determined by family size. It provides a rebate to Americans equal to the NRST on their purchases up to the poverty level. For a family of four this would be a rebate on the first $16,000 of purchases.
{12} Fred and Joan are paying the NRST on the principal over 30 years.
{13} Fred and Joan would not pay NRST on the FICA payment, the NRST payment and the mortgage payment. We are assuming that the family has savings or expenditures of an additional $5,000 not subject to the NRST - like charitable donations, education expenses or savings.
{14} We are making the same assumptions as in footnote 13.
{15} Many economists believe that the mortgage interest rate will likely be even lower because of the increase of savings and the infusion of vast amounts of capital from around the world.
{16} This assumes that the family saves or spends a total of $5,000 on items not subject to the NRST.
But if the price BEFORE tax was $10, the price AFTER tax would be $13...meaning 3 of 13 was tax (ie 23%).
It is against the desires of our government that we understand tax inclusive rates IMO. Income taxes are figured tax inclusive.
WHen one thinks of sales tax, one thinks of adding that percent to the price of the good/service. Hence the fact that the nrst is a "sales tax" leads many to erroneously assume the rate is added onto the price.
The rate is whateevr rate is needed to make it so total out of pocket is 23% federal tax.
No it doesn't. First of all, the tax is only on the improvements to the property -- this price of the property itself is not subject to the NRST since it is deemed already taxed. Depending on the price of land and the type of house, this can lead to half or more of the selling price being untaxed.
Secondly, the NRST would provide better incentives to house ownership. Instead of just interest being paid with pre-tax dollars (subject to deduction limits like the AMT), the principal and interest are both paid with pre-tax dollars. Interest rates will drop by 25% or more (compare tax-free to taxable bonds to see this effect in action already). And you, the builder, will see your production prices will fall as the effects of removing the tax ripples through the entire chain of production.
If you stop there, you're showing signs of understanding.
AR, your houses are already loaded with 22% (tax inclusive) or 30% (tax exclusive) tax.
Eevrything you buy to build with (nails, screws, lumber, etc) has an inflated price.
Are you making progress? NRST would be great for new home sales. I've got a dozen yrs in the RE industry myself.
They're also paying a NRST on the mortgage interest...Interest is the fee you pay for buying/borrowing money.
Don't beleive me? Check out `CHAPTER 8--FINANCIAL INTERMEDIATION SERVICES...
`(3) IMPLICITLY CHARGED FEES FOR FINANCIAL INTERMEDIATION SERVICES-
`(ii) with respect to any underlying interest-bearing debt, the product of--`(I) the excess (if any) of the rate paid on such debt over the basic interest rate (as defined in section 805); and
`(II) the amount of the debt.
You know you are misinterpreting that section of the code, because this has been explained to you many times. What you are quoting is to cover cases where the interest rate includes additional service fees -- only those additional fees would be subject to the tax, not the entire interest rate.
For example, I've owned a mutual fund where there was an annual 0.75% management fee removed from the rate of return (or taken out of the principal in the cases of a loss or negligible gain -- but this particular fund returned about 14% a year at the time) -- that fee would be subject to tax, but not the rest of the interest earned (in this case) or paid.
His sole purpose is to turn people away from finding out about the nrst. He has a vested interest in keeping the current income tax mess in place. He likes it. Ask him.
Wait a minute. You forgot that the exact science of competition would force you to lower your home prices 30% because of the repeal of your federal taxes...
I guess you didn't know, as they do, that you're paying 30% federal tax on the gross sale of your homes. < /sarcasm >
And if you're a contractor or any other profession perfoming a service you too can lower your prices 30%...never mind the fact that you'll eventually have to pay tax out of your reduced income when you choose to spend it...
< /sarcasm >
It provides the money for the governments daily operations (at least till the baby boomer start retiring en masse), It is the justification for the numbering and tracking of all Americans, It allows the intrusion into the daily economic (and personal) life of all Americans. This is the basis for our way of life (covert control vs overt control), as it makes all the government controls look like they are voluntary for citizens and keeps them hidden. Doing away with FICA is unthinkable (to Republicans and Democrats) for these reasons.
It depends on what your state sales tax is. Their "NRST" is really a tax "of the gross payment"
Your $10.00 item with a 7% state tax would be $13.90.
$3.90 is 23% "of the gross payment".
If you would like to be added to this ping list let me know.
John Linder in the House & Saxby Chambliss Senate, offer a comprehensive bill to kill all income and payroll taxes outright, and provide a IRS free replacement in the form of a pure consumption tax:
H.R.25, S.1493
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.
Another classic lewislynn lie. The NRST does not tax taxes. The state and federal sales taxes would be calculated exclusive of each other. But never let facts get in the way of lewislynn's agenda...
WRONG!
From a builder of new homes, the NRST sucks BIG TIME.
Interesting, others in construction find otherwise:
Associated General Contractors of America Legislative Information --- Testimony Submitted on the Fair Tax, H.R. 2525
Mr. Chairman and Members of the Committee on Ways and Means:
The Associated General Contractors of America (AGC) has endorsed the FairTax national sales tax (currently embodied in H.R. 2525) that is promoted by the Americans for Fair Taxation. This federal legislation would eliminate the death tax, self-employment taxes, corporate and individual income taxes, the alternative minimum tax, the capital gains tax and replace these taxes with one simple, single rate, national sales tax on the personal and final consumption of goods and services at the retail level only. It would not affect social security benefits, but simply change the funding mechanism. It would not affect those Federal excise taxes used to fund construction programs. In this endorsement, AGC joins other significant national business groups including the National Small Business United (the nation's oldest small business organization) and the American Farm Bureau Federation among other notable groups.
(14) Taxable property or service-
You people really need to read and understand your product before trying to sell it.
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