Nov162016

Trump’s tax plan will shift housing demand from move-ups to entry-level

By greatly reducing the tax advantage of mortgage debt, many high-wage renters may choose to remain renters rather than assume large debts to buy a house. However, by reducing taxes on lower-income Americans, Trump’s tax plan should stimulate demand for entry-level housing.


home mortgage interest deductionOver the years, I wrote several posts critical of the home mortgage interest deduction because it’s an expensive tax subsidy that only serves to inflate house prices in areas dominated by high wage earners. While several options exist for modifying, replacing, or eliminating the subsidy, only one of these options is politically feasible — and it’s the one Trump proposed.

As it stands today, only a small segment of high wage earners claim this deduction. In theory, this subsidy benefits high wage earners, but in reality, it doesn’t work that way. High wage earners use this tax break to offset the cost of borrowing more money, so in the end, the benefit of the deduction doesn’t accrue to high wage earners, it ends up in the hands of bankers who loan high wage earners the extra money to buy more expensive houses. In the process, high wage earners bid up house prices to a higher equilibrium price level than they would if the subsidy didn’t exist.

As a taxpayer, how do you feel about a $100 billion subsidy the only serves to benefit bankers?

The people who benefit from government subsidies never see a good time to reduce or eliminate them. But what would happen if Congress eliminated the home mortgage interest deduction?

Would we build fewer homes? No, but we might build fewer McMansions.

Would working-class Americans find housing less affordable? No, since they don’t take advantage of this subsidy now, it won’t impact working-class Americans or the markets for lower-priced homes at all.

Realistically, if this deduction were removed, house prices would fall in neighborhoods dominated by high wage earners. Either that, new buyers would endure a higher cost of ownership to sustain prices paid by those who took advantage of the subsidy. In either case, the disruption to the market would be isolated to only those neighborhoods, and arguably, those impacted can afford the change.

Curbing the Home Mortgage Interest Deduction

It’s very unlikely the home mortgage interest deduction would be suddenly eliminated. The potential for disruptions to the housing market are too great, and the lobbyists would spend millions “educating” lawmakers on the perils of a sudden change. What is far more likely is that any change would be phased in and subject to “grandfather” clauses allowing people with existing mortgages to keep some or all of their existing benefits.housing_consumer

Proposals to reform, reduce or eliminate the home mortgage interest deduction come in 3 varieties:

1. Reduce the loan size limit, generally with a phase in or grandfather clause.

2. Shift the benefit from a deduction to a credit to help low-income borrowers instead of high-income borrowers.

3. Raise the standard deduction to reduce the positive impact.

The home mortgage interest deduction caps are $1,000,000 for a primary mortgage and $100,000 for a HELOC. If lawmakers reduced the limits on loans amounts eligible for the HMID to $500,000, it would only effect high wage earners. This would be politically unpopular, and Trump’s tax platform makes no mention of this proposal.

Another proposal is to change the HMID from a deduction to a credit. This would be a boon to low-wage earners who don’t itemize and who don’t benefit from the current deduction. It would be a disaster for high wage earners who would see a huge deduction replaced with a paltry credit. Again, this would be politically contentious, and Trump’s tax platform makes no mention of this proposal either.

Raising the standard deduction is the most politically palatable option because it’s a stealthy way to reduce or eliminate the home mortgage interest deduction without causing a political firestorm — and this is in Trump’s tax plan.

The Trump Plan will increase the standard deduction for joint filers to $30,000, from $12,600, and the standard deduction for single filers will be $15,000.

So how would increasing the standard deduction impact the home mortgage interest deduction?

When people file taxes, they can either itemize or take the standard deduction. Only high wage earners with deductible expenses greater than the standard deduction itemize, and most of them do so because they have a large mortgage debt that costs them more than $12,600 per year in interest.conehead

At 4% mortgage rates, any family with a mortgage larger than $315,000 pays more than $12,600 in mortgage interest debt alone to prompt itemizing on taxes. Most Coastal California homebuyers borrow more than this amount because house prices are so high, it’s a necessity. If the standard deduction were raised to $30,000, only borrowers with mortgage debt exceeding $750,000 would pay the $30,000 in mortgage interest that provides them enough deductible expenses to itemize. A huge swath of Coastal California borrowers will stop itemizing and stop taking advantage of the HMID.

Further, since high-wage renters would have a $30,000 personal exemption, the pressure to buy rather than rent would lessen, reducing demand overall.

The current home mortgage interest deduction provides a strong incentive for high wage earners to buy rather than rent. This distorts the market in areas like Coastal California and inflates house prices, and in the end, the subsidy only benefits bankers.

This is a populist approach as Trump’s website notes:

The Trump Plan protects all low-income and middle-income Americans and lowers their taxes.

An increase in the personal exemption is a major tax cut for low-income and middle-income Americans because it reduces their taxable incomes by $18,400 per year. Increased disposable income will increase demand for low-end housing. So while the increased personal exemption may reduce demand in high-cost neighborhoods, this may be offset by increased demand in low-cost neighborhoods.

A major political realignment

We are witnessing a historic political realignment in America. The Democrats used to be the party of labor unions and the working-class, and the Republicans were the party of management and the wealthy elites. Hillary Clinton sold out to the elites and financial interests and lost the working-class vote. Donald Trump galvanized the working class, much to the chagrin of establishment Republicans, and Trump seems intent on enacting legislation contrary to long-standing desires of the Republican establishment. If he stays on this course, he will find much support from Democratic lawmakers in working-class districts. He risks fracturing his own party in the process, but as a pragmatic dealmaker, I believe he will find the middle ground where it exists.

Populists succeed by breaking down the barriers erected by the elites. Andrew Jackson and Teddy Roosevelt were hated and opposed by many in their own political parties. Teddy Roosevelt, a Republican, passed and enforced anti-trust legislation that destroyed the financial structures erected by decades of Republican rule. In the process, he became one of the most successful and popular presidents of all time.

Will Trump follow in Teddy Roosevelt’s footsteps? Will he break the ossified structures put in place by the elites to screw over the common man? He’s uniquely positioned to be one of the major surprises in political history — or one of it’s biggest disappointments.

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