Correction to This Article
Some labels on the charts on the front page of today's Real Estate section, which was printed in advance, are incorrect. The charts compare the effect of proposed changes in tax law on four different homeowners. In each chart, the first set of shaded figures should be labeled "With Current Deductions" and the second set should say "Under Proposed Plan."
Deduction Eruption
Tax Proposal May Not Float, But It Sure Is Making Waves

By Sandra Fleishman
Washington Post Staff Writer
Saturday, November 12, 2005

First things first: The current tax breaks for your house aren't going away anytime soon.

There's too much entrenched opposition to the proposals made Nov. 1 by the presidential advisory panel on tax reform.

Key provisions of the plan would:

Limit tax breaks to mortgage loans on primary homes.

Replace the mortgage-interest deduction with a tax credit equal to 15 percent of the interest paid.

Cap the amount of the loan eligible for that credit. The cap would be set locally, depending on prevailing prices. The proposed range is $227,000 to $412,000, with the District and nearby jurisdictions at the high end.

Phase in the caps over a five-year period.

Eliminate the deduction for state and local taxes.

Currently, taxpayers can deduct interest paid on mortgage loans up to $1 million for first and second homes, plus home equity loans of up to $100,000. They can also deduct their property taxes.

Those deductions, part of the original 1913 tax code, are a long-cherished benefit of homeownership, which is why the proposal might be as doomed as similar proposals have been for decades. The new plan drew immediate outrage from the housing industry, with claims that if it were implemented, home values would immediately drop 15 percent, and consumer confidence would fall.

Others disagreed, saying prices might fall about 8 percent for higher-cost homes, which would take the biggest hit under the proposal; but demand would shift to less-expensive houses. That could set off a kind of ripple effect, in which lower-income people would be able to buy houses, whose sellers would, in turn, move up to more expensive properties. Advocates also contend that the proposal would spread wealth to those most in need, in contrast to the current code, which they say encourages the building of McMansions and second homes rather than entry-level housing.

In essence, the proposed changes would mean that homeowners would get no more than a 15 percent tax benefit from their mortgage no matter what their tax bracket.

That automatically would mean a loss for higher-income taxpayers with big houses. For example, anyone in the 35 percent bracket can now reduce his or her tax bill by an amount equaling 35 percent of the interest paid (up to $1.1 million) and 35 percent of the property taxes paid.

A lower-income person, on the other hand, gets less of a benefit -- because a $10,000 mortgage interest deduction cuts taxes $1,500 for a person in the 15 percent bracket, but $3,500 for a person in the 35 percent bracket.

Furthermore, the 65 percent of taxpayers who don't itemize deductions "don't see the benefit at all" under the current system, said Dean Baker of the Center for Economic and Policy Research. The panel's proposed 15 percent mortgage interest credit, in contrast, could be taken without itemizing.

Advocates also point out that taxpayers should consider the panel's proposal as a whole. Beyond the provisions that are hot buttons for homeowners, the panel proposes other substantial changes, including lower tax rates and investment taxes and larger credits for children and savings.

"If people lose in one provision, we've made it up in other areas," panel spokeswoman Tara Bradshaw said.

For example, the plan eliminates the alternative minimum tax, which affects mostly upper-income taxpayers. The AMT was designed to prevent millionaires from avoiding taxes but next year will affect 21 million taxpayers earning as little as $75,000.

The real estate industry's quick, sharp attack on the plan led many observers to declare the proposal dead on arrival. The National Association of Realtors, Mortgage Bankers Association and other industry leaders insist that the deduction would drive home prices down as much as 15 percent and undermine consumer confidence, slowing a major engine of the economy.

Jerry Howard, chief executive and vice president of the National Association of Home Builders, pledged Thursday to "do our best to convince the administration to reject the proposal." The trade association released a survey of 800 likely voters by Public Opinion Strategies taken last weekend that found that 75 percent opposed the proposals.

NAHB President David F. Wilson said the plan will "mean a big tax hike for millions of American homeowners, will reduce home values and will send a chill throughout the housing market." The custom-home builder from Ketchum, Idaho, said high-cost areas would "bear the brunt" of changes, which would "cripple those communities that rely on second homes and vacation homes as a major source of their economy." NAHB president-elect David L. Pressly said middle-class Americans would be hurt the most, and "the newest homeowners will probably be hit the hardest."

"If [the recommendations] are not dead on arrival [they're] on death's doorstep in Congress," Kenneth Mayland of ClearView Economics told Market News International. Rep. Gerald C. Weller (R-Ill.), a member of the House Ways and Means Committee, which oversees tax legislation, said seven of 24 Republicans have already signed a letter opposing the plan.

Robert Curran, senior director and home building analyst at Fitch Ratings, said that the most that is likely to happen is a reduction in the current $1.1 million loan cap.

But the panel's report makes a case for challenging the unfairness in what amounts to a $75 billion annual subsidy for housing. "Under current law, the tax benefits for housing, which are larger than the entire budget of the Department of Housing and Urban Development, mostly go to the minority of taxpayers who itemize deductions," the report said. ". . . These taxpayers typically are drawn from higher-income groups. Over 70 percent of tax filers did not receive any benefit from the home mortgage interest deduction in 2002."

According to the Joint Committee on Taxation, the report continues, "more than 55 percent of the estimated tax expenditures for home mortgage interest deductions went to the 12 percent of taxpayers who had cash income of $100,000 or more in 2004."

The home builders and Realtors warn that the proposal could shatter the nation's 69 percent homeownership rate. But the panel looked at countries that don't allow home mortgage interest deductions for tax purposes, including Britain, Australia and Canada -- and found little difference. The rate of home ownership is about the same in Britain, 70 percent in Australia and 66 percent in Canada.

Among the supporters of tax changes in the housing area are people as diverse as Robert B. Reich, who was President Bill Clinton's secretary of labor, and Kevin A. Hassett, director of economic policy studies at the American Enterprise Institute.

Hassett said prices would drop perhaps 8 percent for expensive homes, but less expensive houses could see increases because many people who currently receive no tax subsidy would get the 15 percent home credit. And lower-income families' increased buying ability could offset price declines higher up the chain, he contends, because it would increase demand from the people who sell to them and can then move up.

Treasury Secretary John W. Snow is charged with responding to the recommendations, under the executive order President Bush issued in January when he announced the formation of the bipartisan tax commission. Snow has not yet said when he would respond.

Congress must then take its shot at any proposed legislation.

While action on the plan may not occur anytime soon, some think the seeds of change have been planted.

"The fact of the matter is, I don't think anyone intended for action to be taken on it this year. . . . There's no time to consider anything this voluminous," said Tom Ochsenschlager, vice president of taxation for the American Institute of Certified Public Accountants. "I'm thinking not much will happen until 2007. . . . But it does put all this stuff into play. And people will be able to say . . . some of the greatest minds in the country came up with this idea."

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