We’re focusing this month not on the employment report (which was pretty good) but on the tax reform plan crafted by House Republicans, which, housing industry trade groups have concluded, is not good at all for the housing market.
These are early days in what promises to be a spirited (to say the least) debate. Many components of the plan are controversial, and some may prove toxic. This is far from a legislative done deal, and its prospects for winning approval in the House and Senate in the current form – or in any form – are far from assured.
That said, as currently proposed, several changes would dramatically alter the tax treatment of home ownership by:
- Doubling the standard deduction to $12,000 for individuals and $24,000 for married couples. This would significantly reduce the value of the interest deduction for many consumers, and, industry executives warn, would eliminate a major incentive for owning a home.
- Cap the maximum mortgage on which interest could be deducted at $500,00 ─ half the current cap of $1 million dollar ─ and permit deductions only on a primary residence; vacation homes would no longer qualify for the mortgage interest deduction.
- Set a $10,000 limit on deductions for state and local property taxes – more liberal than the original proposal which would have eliminated the deduction entirely, but a blow to owners in high housing cost states.
- Tighten the exclusion on gains from the sale of a primary residence. Under the proposed rule, sellers would have to have owned and occupied the home for five of the previous eight years and can claim the exclusion only once every five years. Under existing rules, the occupancy requirement is two of the past five years, and the benefit can be claimed every two years. The exclusion would phase out for higher-income owners, for whom the gain exclusion would be offset by earnings exceeding $500,000 (for a couple).
Giving and Taking
Facing the daunting task of reforming a tax code containing loopholes and tax breaks for virtually every conceivable interest group, lawmakers have been engaged in a complicated process of give-and-take – trying to give enough benefits to key interest groups to offset advantages being taken from them, without increasing the cost or upsetting other interest groups.
That effort was obvious in the housing provisions. Anticipating staunch defense of the mortgage interest deduction – long-considered to be politically untouchable ─ drafters initially proposed replacing the deduction with a home ownership tax credit. Breaking ranks with the National Association of Realtors (NAR) and other housing groups, which immediately opposed the idea, the National Association of Home Builders (NHAB) initially said it could support the tradeoff. But when the final proposal eliminated the tax credit and halved the interest deduction, the builders quickly and angrily rejoined the opposition.
“It’s a bad bill for the housing sector,” Jerry Howard, CEO of the trade group, told reporters. “We will do everything we can to defeat this thing.”
The NAR had already attacked the plan as harmful to middle class homeowners, harmful to the housing industry, and potentially harmful to the economy. “Eliminating or nullifying the tax incentives for homeownership puts home values and middle-class homeowners at risk, and from a cursory examination, this legislation appears to do just that," NAR President William Brown, said in a statement.
The combined effects of slashing the mortgage interest deduction, reducing its utility (by raising the standard deduction), and reducing the capital gains exclusion for home sales will be to reduce incentives for people to buy homes, discourage existing owners from selling and potentially depress home values nationwide, Brown warned. "You're talking about potentially causing housing recessions in some of the biggest markets in the country, and those kinds of recessions tend to have spillovers," he said adding, "We're worried about a national housing recession."
An Unexpected Debate
The opposition of housing industry trade groups isn’t surprising. But the tax plan has also triggered an unexpected debate over the value of the mortgage interest deduction, exposing skepticism that has been increasing quietly for some time, as analysts have questioned the assumption that the interest deduction provides an essential incentive for home ownership. A recent study by MIT economist Jonathan Gruber is one of several to conclude that the deduction, in fact, has “zero effect” on the decision to purchase a home.
Other housing policy analysts, and many liberal advocates of affordable housing, have argued for some time that the deduction primarily benefits higher-income homeowners who purchase more expensive homes (with larger mortgages and higher interest payments), and are far more likely than less affluent owners to itemize deductions.
The Congressional Budget Office has calculated that 75 percent of the benefits of the deduction go to the top 20 percent of earners. Todd Sinai, a real estate professor at Wharton, points out that mortgages larger than $500,000 (the break point for deductible interest under the prosed tax plan) represent a tiny portion of the total, and even for those large mortgages, he notes, interest on the first $500,000 would still be deductible. The limit “only affects a couple percent of households,” Sinai told The Atlantic, “and they are the households that can buy expensive homes.”
For the National Low-Income Housing Coalition, which has long contended that the federal “subsidy” provided by the interest deduction far outstrips federal funding for affordable housing, the tax plan represents an “historic’ step toward addressing that inequity. The problem, Diane Yentel, the group’s president, told the Atlantic, and the reason the organization is opposing the tax bill: It would use the savings from capping the interest deduction not to provide more affordable housing, but to lower corporate tax rates “which for us is a non-starter.”
The provisions affecting housing represent only a small portion of a 400-plus page proposal that has many complicated and equally controversial components. It’s a spider’s web of interconnected strands on which hundreds of interest groups are tugging. With, as one columnist noted, “a lobbyist looming over every proposed change,” it is impossible to predict what the bill will look like when it finally reaches the floor of the House, how it will compare to the version the Senate will produce, and what a House-Senate compromise – if one can be reached – will bring.