Monday, November 07, 2005

Mmmm, Tax Simplification: Would-Be Regional Variation In The Mortgage Interest Deduction

by Tom Bozzo

Among the tax "reform" panel's most controversial recommendations has been its proposal to reduce the tax subsidy for mortgage interest. This is done by two primary means: Converting the deduction into a 15% credit, which other things equal is a tax increase if you're in the 25% bracket or better — for 2006, that's estimated to start at $29,050 in taxable income (i.e., after deductions and exemptions) for a single taxpayer, twice that for married joint filers; and establishing limits on mortgage balances eligible for the credit based on regional home prices. The cap would be 125% of the median price used to set FHA loan limits (Report, Ch. 5, p. 73).

In yesterday's NYT, Edmund Andrews inaccurately characterized the proposal as limiting the size of mortgage eligible for a tax credit from $1.1 million to about $412,000. Outside the high-cost metropolitan areas, that might not seem too bad, but the $412,000 is only applicable to the highest-cost areas (*).

Apart from requiring a lengthy table to determine the applicable mortgage limit (as noted at Talking Taxes; link via MaxSpeak), the limits would be subject to quite variable changes by area due to market conditions. Some metropolitan areas have seen very little, if any, appreciation — IIRC, Texas metropolitan areas routinely bring up the rear — while prices have soared in the bubbly coastal markets. Of course, some of those markets might be subject to substantial declines in the case of a prolonged effervescence adjustment. The main text of the report doesn't discuss possible adjustment mechanisms for the caps.

Since the FHA limits are determined by MSA and have (in addition to the high-cost ceiling) a floor that applies to low-cost areas, there are large and odd regional variations in how much house you can deduct. These don't make any obvious sense. Here are some jewels of the upper midwest, compared to a notoriously bubble-like area:

CountyMortgage LimitMedian Existing House PriceLimit, % of Price
Green, WI (Rural South Central WI)$227,147$125,900 (**)180%
Sauk, WI (far Madison exurbs)227,147150,000151%
Brown, WI (Green Bay)227,147149,300152%
Dane, WI (Madison MSA)267,368200,000134%
Milwaukee, WI256,315144,300178%
Waukesha, WI (Milwaukee MSA)256,315234,800109%
Hennepin, MN (Minneapolis MSA)321,875230,000 (13-cty Metro, 9/05)140%
Cook, IL (Chicago MSA)362,105265,000 (Q2) 137%
San Francisco Bay Area411,703726,900 (Q2)57%

Can't say I feel bad the reforms were DOA...

(*) Yet higher limits apply outside the 48 contiguous states.

**) Wisconsin figures are for Q1 2005, from the Wisconsin Realtors Association.
I note for the record that Andrews adjectives "taxing - albeit very gingerly - employer-paid health insurance."

Without having looked at the report (i.e., only from the headlines) it was a tax on any HI premium paid by the company over $5,000 per year.

My current employer--hardly the most generous with employee benefits; e.g., no matching of 401(k) at all--has paid just shy of $12K so far this year for this family of four.

Granted, I took the most comprehensive insurance they offered. (Small children cause such decisions.) But that's still probably an average of around $1,000 additional tax ($5K in currently-non-taxed benefits per family at around 20%).

It's not the redistricting effort that the Mortgage deduction implies, but rather the VAT-through-the-backdoor that is most reminiscent of 1986's "no more deducting credit card interest, but a HELOC is fine."
Ken: The $5K limit would be for an individual -- it's $11.5K for a family. (A table summarizing the two proposals is on p. 61, Ch. 5). So it wouldn't be quite that bad. Proposed CPI indexing of the limit would, however, gradually increase the taxation of health benefits -- at least until price increases that can't go on forever, don't.
Good to see the proposal is saner than the headline.

I knew Solow was the source of Galbraith's list. What I fail to see--or he fails to mention--is why he thinks Solow applies in a case where you are specifically saying (in the best of all possible worlds, as opposed to the one in which most of us live) that the mean skill level has to go up to keep pace with the other changes from free trade.

In a closed system, population growth should increase productivity; but free trade definitionally "opens" the system (though it does not create an open system).
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