Will the Housing Market Be Fine after Tax Reform?

AEI’s Alex Brill wrote:

The prospect of major tax reform that broadens the tax base and lowers tax rates has the residential housing industry in panic mode. The National Association of Realtors recently called the House tax bill “an outright assault on homeownership in America.” Separately, a study commissioned by the Realtors warns that comprehensive tax reform would result in an average drop in home values of 10%. But the reality is that the housing market will be fine if the House Republican tax plan is enacted.

Yes, the number of taxpayers who choose to itemize their deductions would decline as a result of the House GOP tax plan, which nearly doubles the standard deduction and repeals or limits other itemized deductions. But to jump from that to warnings of a precipitous housing market decline demonstrates a lack of understanding of the effect of existing tax policy on the housing sector.

To grasp the relevancy of the mortgage interest deduction today, consider the example of a married couple who purchase a house for $213,099, the median home price for homes sold in the US in the second quarter of 2017. First-year interest payments, property tax payments and other potential deductions combined would almost certainly total less than the couple’s standard deduction, $12,700. Given this, these homeowners, and most of the millions of new homeowners buying less costly homes, would never receive a tax benefit from the mortgage interest deduction.

Even for a taxpayer buying a more expensive home, the mortgage interest and property tax deduction would only benefit the homeowner to the extent that the amount exceeds the standard deduction minus other deductions. For example, a married taxpayer with $3,000 in charitable donations, $2,000 in state income taxes, and $10,000 in combined mortgage interest and property taxes would receive a housing-related subsidy equal to a deduction of just $2,300, the amount that the $10,000 exceeds the $12,700 standard deduction after accounting for the other deductions. Over time, as the value of the standard deduction rises with inflation and the amount of interest paid per year on the mortgage falls, the value of the housing-related subsidies declines further. Simply put, the narrative that every homeowner relies heavily on the mortgage interest deduction is overstated. And for many, the tax benefit accrues only for a few years, if at all.

Further refuting the panic is a new academic paper, forthcoming in the journal American Economic Review, analyzing the impact of a full repeal of the mortgage interest deduction. Economists Kamila Sommer and Paul Sullivan’s most important result, tucked into Appendix C of the online version, is that home prices under this reform would decline just 2% given the current interest rate environment, far less than the dire prediction made in the Realtors study. But even Sommer and Sullivan’s result, which accrues over a matter of years, likely overestimates the impact of the House Republican plan for three reasons.

First, the House GOP tax plan is less radical than the scenario studied by Sommer and Sullivan. The House GOP plan grandfathers all existing mortgages, continues to permit a deduction for the interest on the first $500,000 in mortgage debt and allows up to $10,000 in property tax to be deductible.

Second, Sommer and Sullivan makes a simplifying assumption that under current law all mortgage interest is tax deductible. Using the AEI Open Source Policy Center’s tax calculator, I estimate that just 75% of mortgage interest is deductible, an assumption shared by the economists who conducted the Realtors study. Moreover, I estimate that only two-thirds of taxpayers who itemize claim 100% of the tax benefit of their mortgage interest deduction. The rest claim an average tax break on just a small portion of their mortgage interest because their other deductions do not entirely exceed the standard deduction. This reality should further reduce the already small impact reported by Sommer and Sullivan.

And finally, comprehensive tax reform will increase after-tax incomes for most taxpayers, and the significant cut in the corporate tax rate from 35% to 20% will likely spur domestic investment and further increase household incomes. Higher incomes could increase demand for housing and put upward pressure on prices until the aggregate housing stock adjusts. If the final tax bill achieves the pro-growth objectives lawmakers desire, the net impact for housing could even be positive.

Realtors, homebuilders, and homeowners should relax. Tax reform may actually be a boon for housing.

 

Alex Brill is a resident fellow at the American Enterprise Institute.

 

Source:
AEIdeas
Alex Brill
November 9, 2017