The New York Times reported that Senate Democrats and Republicans reached a tentative deal on the new housing bill. Among the various provisions is a federal income tax deduction for property tax paid by taxpayers who don't itemize deductions. Single taxpayers get a $500 deduction. Married taxpayers filing a joint return get $1,000. Presidential candidate senator Barack Obama also proposed a "universal mortgage credit" which gives a refundable tax credit to taxpayers who pay mortgage interest but don't itemize deductions.
The rationale behind these proposals is that the mortgage interest deduction and the property tax deduction benefit only the well-off. They say people who don't itemize their deductions don't get those deductions. From Obama's Tax Fairness Plan:
"Owning a home is the culmination of the American dream that so many Americans work so hard for. The tax code is supposed to encourage home ownership with a mortgage interest deduction, but it goes only to people who itemize their tax deductions. Like so much in our tax code, this tilts the scales toward the well-off. The current mortgage interest deduction excludes nearly two-thirds of Americans who do not itemize their taxes."
Is that so? On the surface, yes. If you don't itemize your deductions, you use the standard deduction, which in 2008 is $5,450 for single and $10,900 for married filing jointly. If you pay mortgage interest and/or property tax, but if they are not large enough, you still use the standard deduction. That's why by definition Americans who don't itemize their deductions don't show a mortgage interest deduction on their tax return.
However, to say that those Americans don't benefit from the mortgage interest deduction or the property tax deduction is a misunderstanding of how taxes and math work. The tax law says everybody is allowed to itemize their deductions. Everybody starts out listing their mortgage interest, property tax, state income tax, plus any other deductions they are allowed. Say for a married couple filing jointly, those deductions add up to $6,000, then the IRS tells them
"Guess what, you are lucky. We are going to let you deduct even more than what you've already got here. Would you like us to top off your deductions to $10,900?"
Now they can take up on the offer from the IRS or say "no thanks" and stick to their original list of deductions, which include their mortgage interest, property tax, state income tax, and everything else. In reality, when one has less in deductions than the standard deduction, nobody declines the sweet offer from the IRS because they get to deduct all the deductions they are allowed, plus a bonus deduction offered by the IRS.
Now tell me who's better off? The taxpayers who don't itemize their deductions but end up deducting even more than their deductions, or the taxpayers who itemize their deductions? The non-itemizers get to deduct everything they are allowed plus a bonus deduction they receive from the IRS. Itemizers don't receive such bonus. The non-itemizers are already better off than the itemizers. If we allow a new property tax deduction under the proposed housing legislation or a new "universal mortgage credit" under Obama's tax plan, the non-itemizers will deduct their mortgage interest and property tax twice, plus taking a bonus deduction from the IRS. Does that sound like fair to you?
I'm afraid our legislators and presidential candidates don't understand how taxes and math work because they don't do their own taxes.
11 comments:
Yeah, this is kind of a wild deal... As always, lots of people getting wound up over a tax system that they don't understand!
:)
Well at least it brings one thing in line. I read a lot of financial blogs online and they are always pointing out how mortgages are better than other debt because you can deduct the interest.
That may be for some people, but I couldn't afford a house big enough to take that deduction. Now a mortgage can still be a reasonable kind of debt for me (has a low fixed interest rate, ends with me owning my home, etc.), but it has no special tax advantage.
At least now, those authors will be able to point out that I save an extra $150 in federal taxes each year.
Obama is right in one sense. If the point is to encourage home ownership, then the current tax setup doesn't do that as well as it seems. It may be true, as you argue, that it isn't unfair, but it also provides no incentive to people like me to own a home
That might actually be a compelling point. If we encourage home ownership because of the other social advantages that go with it, then perhaps it is the less well-off that specifically need the incentive to own homes.
I think a fair and simple solution is to make mortgage deduction an above-the-line deduction.
Anon - Making the mortgage interest deduction an above-the-line deduction will be criticized as a tax cut for the rich. How about getting rid of the standard deduction? That way people like Don will be encouraged to buy a house because they will see a difference in their tax bill when they do.
Why is home ownership so great that we have to encourage it for everyone with more incentives?
Maybe if our system hadn't done this the past 8 years we wouldn't have the subprime mess right now. Home ownership is not for everyone.
Not only that, but this proposal will only encourage more borrowing by more low net worth people. Does that sound like something that is really going to help? Looks like a wolf in sheep's clothing to me.
"Anon - Making the mortgage interest deduction an above-the-line deduction will be criticized as a tax cut for the rich. How about getting rid of the standard deduction?"
TFB, Getting rid of the standard deduction? Aren't you talking about more tax on the poor?
Either way will do it, but neither will pass the congress.
My idea: The tax is regressive anyway, get rid of it and give everyone an increased deduction. Renters indirectly pay that stuff in our rent. Also, you could take a HELOC and buy a plasma TV and deduct the interest.
But it is probably too ingrained in the tax system to undo.
Anyway, I read this awhile ago: http://www.nytimes.com/2006/03/05/magazine/305deduction.1.html?pagewanted=print
I was surprised at the origins of this tax which I thought was there to help out the middle class.
StackingPennies - Thank you for the link to the good article by Roger Lowenstein. He is one of my favorite business writers. I remember reading it some time ago. It's worth reading it again. Part of the URL in your comment is cut off due to formatting. Here it is again with hyperlink:
Who Needs the Mortgage-Interest Deduction?
Getting rid of the mortgage interest deduction will work too. It will remove the distortion in the housing market. I think mortgage interest in other countries like Canada and UK are not tax deductible. Their society functions just fine without it.
If you wanted to get rid of the standard deduction and make it more "fair" for the poor you could just raise the personal exemption rate by $5,450. You would end up with the same "deduction" and everyone could deduct all of their mortgage interest.
tfb,
That's a great piece of insight. I imagine I'll be using this one next time someone talks about deductions.
It's amazing how something this obvious can still be promoted at a national level as a great idea.
-John
Nifty News and Decent Deals
"I'm afraid our legislators and presidential candidates don't understand how taxes and math work because they don't do their own taxes."
Or they know perfectly well, but know this move and rhetoric will get them votes!
I've never really understood the whole gov't push towards homeownership, it just seems to inflate housing prices. But I'll take the deduction since those are the rules of the game.
Post a Comment