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Raising standard deduction would reduce the sting, but what about home values?
Widely dismissed as DOA when it was introduced, a massive overhaul of the tax code including perks for homeowners proposed by House Ways and Means Committee Chairman Dave Camp contains a seductive formula that will be at the core of a major tax reform push next year:
- Give corporations the rock-bottom low tax rates they’ve been seeking from Republicans for years.
- Expand the standard deduction significantly enough to pull in the vast majority of the tax-paying public. When the standard deduction exceeds what most people are getting by itemizing, they’ll happily switch to the easier check-the-box approach.
Though the plan has no chance of passage this election year, top Capitol Hill tax policy specialists tell me that real estate professionals who brush off Camp’s plan do so at their own peril.
It’s not just Camp — a Michigan Republican who is the House’s most influential tax policy leader — who supports this combination as the key to simplifying the tax system. So does the Senate’s most important tax legislator, Sen. Ron Wyden, D-Ore., who chairs the Senate Finance Committee.
Wyden, who has promised to soon begin preparations for a joint House-Senate tax system overhaul effort, authored a reform package three years ago based on these two concepts — lower brackets plus a sharply expanded standard deduction. Wyden was not in a position of power then, but he is now.
Camp’s bill promises corporations and individuals maximum marginal income tax brackets of 25 percent, and pushes the standard deduction for joint filers to $22,000 ($11,000 single filers).
But here’s the Trojan horse for housing that has drawn almost no attention: Camp’s bill would essentially eliminate itemization for the overwhelming majority of homeowners, even while leaving the mortgage interest deduction in the tax code at a reduced level.
Though the perennial focus of housing groups has been on preserving the mortgage deduction, Camp’s plan cleverly sidesteps the issue and targets something broader and more significant for homeowners: property taxes.
He would phase down the mortgage interest writeoff from $1 million to $500,000 in principal balance limit in four annual steps, but would end write-offs for property taxes altogether.
The bulk of American homeowners — those with mortgages below $500,000 — would feel no pain from a reduced MID limit. Only top-bracket owners along the Pacific and Atlantic coasts and a few other high-cost enclaves would be disturbed by a phase-down to $500,000.
But the opposite would be true if property tax write-offs were eliminated. (Camp believes local property tax levies too often support excessive and wasteful local spending.)
Homeowners pay upwards of $300 billion in local and state taxes per year, according to industry estimates. Every owner pays at least something in the way of a property levy.
In markets like New Jersey, the median property tax bill was nearly $7,200 in 2012, according to the federal government’s American Community Survey. In Connecticut, New York and New Hampshire, the median is well over $5,000 a year. Even in a lower-cost housing area like Illinois, it was more than $4,500 in 2012.
The property tax write-off is the foundation upon which all other special-interest tax benefits rest, said one top policy analyst. On top of it comes the mortgage deduction, charitable contributions and other preferences that move millions of taxpayers past the standard deduction and into “Schedule A Land.”
Take the property tax deduction away, and it’s much tougher for homeowners in most parts of the country to get to the point where itemizing saves them big money. Raise the standard deduction to $22,000 and you’ve basically dismantled the attraction of itemization.
Which, of course, is the core cleverness in Camp’s (and possibly Wyden’s) approach: Simplify, streamline and clear out the long list of goodies that have been thrown into the code over the years for special interests like housing.
That way you can also lower everybody’s top tax brackets — especially for the corporate community whiners who say the current code’s high rates make U.S. businesses less competitive against global competitors.
OK, this all makes some sense in terms of tax simplification political strategy. But let’s talk real estate economics: At what point do lower rates and streamlining begin to chip away at the traditional values associated with homeownership? At what point does the end to itemization for most taxpayers make the financial benefits sufficiently less attractive that values come down?
Academic and industry studies over the past decade have concluded that current tax code benefits are baked into home prices and account for anywhere from 12 to 18 percent of market value. No published studies have yet attempted to estimate the impact on home prices of a total or near-total elimination of itemization itself combined with lower tax brackets.
But it’s a reasonable assumption that when you strip away tax subsidies from a commodity, the value of that commodity will drop.
In the case of the Camp bill, the stripping away would be thorough-going: not only property taxes, but deductibility for home equity lines, a stretch-out of the qualifying time for capital gains exclusions (five out of eight years rather than two out of five years), no mortgage debt forgiveness tax relief and more.
Bottom line: The goals of corporate tax reduction and simplification are alive and well on Capitol Hill.
Camp’s formulation for real estate — pulling the property tax leg out from housing while increasing the standard deduction — is too clever to ignore as “dead on arrival.”