Friday, November 11, 2005

Why Loss Of Homeowner Tax Benefits Will Cause Real Estate Bust

by Blanche Evans

In a moving letter to Treasury Secretary John Snow, Tom Stevens, president-elect of the National Association of Realtors pleads for extreme caution in deliberations to include the elimination of the mortgage interest deduction in budgetary and legislative proposals. Doug Duncan, chief economist for the Mortgage Bankers Association explains in plain terms why losing this important homeowner tax benefit will throw the housing market into a bust.

Stevens writes, "Now that the President's Advisory Panel on Federal Tax Reform has completed its work, the U.S. Department of the Treasury will be working to convert the Panel's recommendations into budgetary and legislative proposals. The National Association of Realtors (NAR) urges extreme caution in your deliberations, and we ask you to preserve the mortgage interest deduction in any proposals to reform the tax code."

He adds, "America's Realtors are deeply concerned about the Tax Reform Panel's recommendations."

"Housing and the overall real estate market have been the engine of our nation's economy and the heart of America's families. Eliminating the mortgage interest deduction would de-value homes across America, hurting all of America's families. Moreover, such tax reform would place the largest burden on "middle America" -- those who have achieved homeownership through mortgage financing."

"NAR estimates that the value of the nation's residential property could decline 15 percent or more, if the tax reform panel's proposal to convert the mortgage interest deduction to a tax credit takes effect. Entirely eliminating the tax deduction for second homes would have a negative impact on at least 5 percent of the gross domestic product, since second homes accounted for 35 percent of all home sales in 2004."

"NAR is undertaking further research to ascertain the full impact of the tax Panel's proposals on all types of real estate and state and local property taxes. However, our conclusion will not change. Realtors believe the mortgage interest deduction is the single most important tax provision for our nation and our families. Diminishing or eliminating the mortgage interest deduction would hurt all families, the housing market and our national economy."

"On behalf of our 1.2 million members who are involved in all aspects of real estate, I would like to meet with you, at your earliest possible convenience, to discuss potential tax reforms proposals. With your help, we can preserve the mortgage interest deduction for the next generation of homeowners and keep our nation strong and growing."

Explains Doug Duncan, chief economist for the Mortgage Bankers Association (MBA,), "Quite simply what will happen is that the interest expense for borrowing money will rise and that will reduce demand, so the demand side will fall. Second, the value of the tax deduction is capitalized into the price of the house, so if you remove it, the house price will fall by the capitalized value of that deduction."

By how much? It's hard to estimate, but economists suggest between 10 to 20 percent. From a theoretical perspective, it's possible only to guess.

As far as the effects of the real estate tax deduction, Duncan says it is a tax increase "whether you have a mortgage or not, so that will boost the amount by which properties fall, particularly in high property tax states like California and New Jersey. If you own an existing home, it will be fairly dramatic. That won't be the capitalized value -- it would be the carrying costs of the house, so if you eliminate the deductibility of real estate taxes, your total tax load rises and you'll be paying a higher real tax rate on owning that house and that will reduce demand and house prices will fall."

The effects of the loss of the property tax deduction are also difficult to calculate, he says. "They will be more localized because property taxes are determined at local levels."

Lawrence Yun, senior economist with the NAR says, "Residential housing is about 15 percent of the gross domestic product, including new homes, workers to build the homes, income generated from Realtor services, title services, etc., but what is important to realize the housing market has supported consumer spending. Home prices have risen, and homeowners have felt wealthy. Consumer spending is two-thirds of the gross domestic product, and it's been the rising home prices that have supported that. A plunge of 15 percent in home prices would be devastating and put the economy into a recession. It could have severe effects and could put a lot of lenders under water because the collateral value is below the loan amount. You would put financial institutions under stress, and the effects could last for quite some time."


"It would be one of the sharpest recessions for quite some time," Yun hedges.

About the panel's recommendations, Yun acknowledges that there has been no model of the potential disaster that could come from reducing such homeowner tax benefits.

"They realize they are taking away some of the benefit going to the housing sector, and many are saying the housing industry has been subsidized, so let's take that away, but for the short term -- up to five years -- it could be devastating to the economy," he explains. "Flatter taxes or consumption-based taxes should be efficient for the economy, but what is being overlooked is the short-term effects. It's unfair to change the rules in the middle of the game and this 15 percent hit for homeowners is a tax increase. That's very unfair because homeowners didn't anticipate when they bought that there was a possibility this would take place."

Another thing that is suggested is that the people who don't have mortgages or who pay low property taxes won't be hurt. This simply isn't true, according to Yun.

"That is wrong way to look at it," he says. "One can think of the current tax benefit that is accruing, and if you take that away, people will agree home prices will decline. But if you have two identical homes for sale on the same street, one being sold by a person who itemizes and the other being sold by a person who doesn't itemize, it is inconceivable that the home prices will be different because the owner itemizes or doesn't itemize. The owners who don't itemize will lose appreciation, too."

"The only comforting thing its I really don't think it would fly," says Yun. "Seventy percent of the nation are homeowners, and in a democracy it is impossible for any politician to go after 70 percent of the population. People need to be educated and informed of the consequences."

The panel said it was aware that its recommendations are "bold," and Treasury Secretary Snow has said he did not know what ideas the administration would embrace after the Treasury makes it recommendations.

"Now it's up to us," Snow said. The Treasury Department will "take the report, review it carefully, understand the implications and use the report as a starting point for recommendations that we will make to the President."

"The effort to reform the tax code is noble in its purpose, but it requires political willpower," the group said Tuesday in a letter to Snow. "Many stand waiting to defend their breaks, deductions and loopholes, and to defeat our efforts."

An AP report suggested that "members of the panel urged taxpayers and lawmakers to look at the whole plan, not just individual components," so they would know that "withdrawn tax breaks" would be replaced by "simpler benefits."

As the tax-writing House Ways and Means and Senate Finance committees will review the recommendations, so will the NAR. The Board of Directors has pledged to authorize a report on the financial impact of the loss of the mortgage interest rate deduction.

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