Should Taxes Be Regionally Indexed?

[Dreadnaught]

I read the article below about a failed attempt to reduce mortgage interest deductions for couples making below $250,000. Like many of the tax hikes for "the rich" I've heard of since 2008, it gets me thinking about the viability and practicality of indexing taxes regionally.

Simply put, $250,000 is very solidly middle class in a place like New York City, San Francisco, etc. But it's not rich.

That said, as soon as I begin to think about how such an index would work, I assume the fetal position. Any ideas for how it would be possible? Or why it's a terrible idea?

* MARCH 1, 2010

Bid to Curb Mortgage Tax Break Falters

By JAMES R. HAGERTY

The latest effort to scale back some tax deductions on mortgage interest, one of the nation's most-enduring tax breaks, is finding little support in Congress.

President Barack Obama's latest budget proposal, released in February, includes a provision that would shrink deductions for mortgage interest, real-estate taxes, charitable contributions and other items for married couples with annual incomes of more than $250,000, or individual filers earning more than $200,000. Under the proposal, such taxpayers would save 28 cents of tax liability for every $1 of mortgage interest or other eligible expenses, down from 35 cents now.

But the proposal has gained no traction in Congress so far. Members from both parties are concerned about how it would affect both the housing market and charitable contributions, says Matthew Beck, a spokesman for the Democratic majority on the House Ways and Means Committee.

The administration believes the proposal would reduce the deficit and "distribute the cost of government more fairly among taxpayers of various income levels," says a Treasury spokeswoman.

But lobbyists for the real-estate industry say scaling back the deduction would hurt demand for housing at a time when the market remains fragile. "It seems very counterintuitive to impose this kind of pain on an industry that's already suffering more than any industry in America," says Jerry Howard, chief executive of the National Association of Home Builders.

Lucien Salvant, spokesman for the National Association of Realtors, says the proposal "amounts to a tax increase on an important group of homeowners and would rob buyers of the incentive to move up in the housing market."

The Treasury rejects those arguments. "This proposal is unlikely to have any real effect on the housing market since tax benefits are only one small part in determining the overall demand for high-end housing," the Treasury spokeswoman says.

Congress has rejected numerous attempts over the years to scale back or eliminate this deduction, which has been available since the federal income tax was created in 1913. The deduction is often defended as a means of boosting homeownership.

Yet critics of the deduction say that, in practice, the deduction does little or nothing to expand homeownership.

Eric Toder, a fellow at the Urban-Brookings Tax Policy Center, a left-leaning Washington think tank, says that low- to moderate-income people—those who might have to stretch to afford a home—typically don't itemize deductions on their tax forms and so get no benefit from this tax break.

The main effect of the deduction, Mr. Toder says, is to lower the cost of borrowing for wealthier people, most of whom would own property in any case. The deduction also may have helped inflate the housing bubble by subsidizing mortgage borrowing, encouraging people to take on more debt than they otherwise would have.

In a 2007 report, the Urban-Brookings Tax Policy Center argued that the deduction drives up land and housing costs. It recommended replacing the deduction with a tax credit and subsidized savings program for first-time home buyers.

Under current law, taxpayers are allowed to take deductions from home-purchase mortgage loans with original balances of as much as $1 million, plus another $100,000 of home-equity borrowings. This debt can include loans used to buy second homes or even boats that have sleeping quarters, bathrooms and kitchens, says Gregory Rosica, a partner at the accounting firm Ernst & Young in Tampa.

The congressional Joint Committee on Taxation recently estimated that the mortgage-interest deduction this year will reduce tax revenue by about $104 billion. About 75% of those benefits go to people with incomes of more than $100,000 a year, a report from the tax committee found.

Mr. Rosica of Ernst & Young calculates that, for a typical taxpayer with total income of $500,000 and itemized deductions of $50,000, the scaled-back deductions would mean $5,000 of added tax liability. For a taxpayer with $1 million of income and $136,000 of itemized deductions, the added tax liability would be about $13,000, he says.

Write to James R. Hagerty at bob.hagerty@wsj.com

http://online.wsj.com/article/SB1000...148762194.html

[Loki]

Wouldn't it lead major firms to shift their main operations to poorer cities/states?

[Dreadnaught]

Hadn't thought of that one...though most firms are incorporated in Delaware and employ people where they can find talent. What would be the point?

[Loki]

Hadn't thought of that one...though most firms are incorporated in Delaware and employ people where they can find talent. What would be the point?

My point is that if you're a firm that pays its employees $250,000, which gets taxed at a substantially higher rate in NYC than in Buffalo, why not move your operations to Buffalo (or even right outside the borders of NYC)? You can get better employees at the same cost, as they'll follow the money (this is especially true of financial services).

[Illusions]

I'd get the feeling that you'd have to re-adjust the rates near annually to keep up with the people/businesses attempting to game the system.

[Wraith]

I read the article below about a failed attempt to reduce mortgage interest deductions for couples making below $250,000. Like many of the tax hikes for "the rich" I've heard of since 2008, it gets me thinking about the viability and practicality of indexing taxes regionally.

Simply put, $250,000 is very solidly middle class in a place like New York City, San Francisco, etc. But it's not rich.

That said, as soon as I begin to think about how such an index would work, I assume the fetal position. Any ideas for how it would be possible? Or why it's a terrible idea?

Tie income tax brackets to the same basket they use to determine cost of living in an area? Recalc with every census. Administration would be a bit of a pain still, though. It'd also be a slap in the face to everyone who thinks filing taxes is too complex as it is.

Wouldn't it lead major firms to shift their main operations to poorer cities/states?

That's actually a good point. Firms are already willing to pile into places like NYC despite the higher cost of living making it less attractive. This would only increase the draw. It might be fun to see if this could cause a feedback loop that eventually sees every single company and person in the country all crammed into a single city.

My point is that if you're a firm that pays its employees $250,000, which gets taxed at a substantially higher rate in NYC than in Buffalo, why not move your operations to Buffalo (or even right outside the borders of NYC)? You can get better employees at the same cost, as they'll follow the money (this is especially true of financial services).

I think he wanted it the other way. The cost of living is higher in NYC, so people making 250k shouldn't be taxed like they're rich, because in that area they're only upper middle-class, but in Buffalo they'd be rich.

[Dreadnaught]

Hold on a sec -- if the federal tax brackets are meant to be relative to the cost of living, would it really be easy for states/cities to compete on this level? If anything, it would be harder because the playing field would be leveled (except when it comes to state/local taxes).

[GGT]

The deduction also may have helped inflate the housing bubble by subsidizing mortgage borrowing, encouraging people to take on more debt than they otherwise would have.

Part of the reason $250,000 is 'solidly middle class' in NYC is due to COL and housing costs. Same income in poorer states would be considered upper middle class or even wealthy. Business knows that and adjusts accordingly. (If you get a promotion and Transfer from NYC to Nebraska, they'll give you a raise, but you'll make less than $250,000.)

I'd assume anyone buying a home would make their OWN evaluations, as percentage of income and costs, before borrowing to buy. Here's where down payments come to play, and property valuations.

If part of the tax deduction is to encourage borrowing, and benefit the housing industry, then Banks and Realtors have to be part of the process with the individual. ie Figuring local costs, income, and not approving loans that are more than twice annual income, or something along those lines.

Metros with higher property values (and incomes) actually benefit more than others; their loans are higher, they pay more in interest, and have more in deductions. Also need to look at local property taxes....they're all out of synch from state-to-state.

<Rush Limbaugh has a NYC property listed for 13.5 million, but the taxes are comparatively low>

[Loki]

I think he wanted it the other way. The cost of living is higher in NYC, so people making 250k shouldn't be taxed like they're rich, because in that area they're only upper middle-class, but in Buffalo they'd be rich.

My mistake. In that case, the same would happen but in the other direction.

Hold on a sec -- if the federal tax brackets are meant to be relative to the cost of living, would it really be easy for states/cities to compete on this level? If anything, it would be harder because the playing field would be leveled (except when it comes to state/local taxes).

Is New York having trouble getting high paid workers to work in the city?

[Hazir]

Hold on a sec -- if the federal tax brackets are meant to be relative to the cost of living, would it really be easy for states/cities to compete on this level? If anything, it would be harder because the playing field would be leveled (except when it comes to state/local taxes).

The state competition would be reinforced by the indexed federal tax-system. In the long run you'd return to a situation where there is equilibrium again, but probably not at the same level nation wide and definately lower in the areas that are succesfull and highly productive now.

I don't quite see Loki's point because we're not talking about companies but about actual people who will have to set up residence (at least legal) to benefit from lower federal income taxes in another region.

P.S. if Wraith is right; I wish you good luck with that. A counter-index will be real popular given the fact that it will be giving people a tax-break for living in the most desirable places. Because why would there be a Manhattan if people didn't want to desperately live there.

[GGT]

The OP talks about mortgage interest deductions, not income taxes.

NYC has some high property values for purchase, with relatively low property taxes, and they also have rent control.

[Hazir]

And what do you deduct these interest payments from ?

[GGT]

And what do you deduct these interest payments from ?

As the article points out, it's usually only high income earners who can itemize and deduct the mortgage interest from their income taxes in the first place. That says nothing about the middle or lower income earner who got snookered into a mortgage that's over half their annual income.

That's probably why getting rid of the deduction is political.

edit to clarify: Besides our tax codes being fubar, they are already "indexed" by region and income. Definitions of poverty are both local and federal, by who gets refunds or credits (as well as subsidies), affordable property prices and loan arrangements.

Congress and bankers want to use tax law to encourage certain consumer behavior (home ownership with mortgages) that benefit certain industries (banks, realtors, builders) that can create inflationary bubbles.

Looking at just the mortgage interest deduction won't solve any problem, because it's bigger than that.

[wiggin]

An interesting idea, Dread. I think that given the relative inflexibility of the labor market (even in the US), the tax wouldn't cause an immediate equilibrium shift in cost-of-living and population concentrations, so presumably there would be some advantages in the early stages. Furthermore, one can argue that places like NYC, the Bay Area, and other relatively expensive cities (e.g. Boston, Seattle, etc.) are not just by happenstance. People and companies move there to be in the company of other talent. 'Clustering' is an odd phenomenon, but it has its advantages. Those advantages translate into reasons to bear the higher cost of living, salaries, etc. Thus, people are effectively making a cost-conscious choice when they get a job in one of those locales - taking into account all of the tax ramifications and cost of living increases, they'll still take the job, even though in real terms they might end up with more wealth in a less popular city.

My wifey's company is thinking of moving from the Baltimore-Washington axis to the Cambridge/Boston area, and they have spent a lot of time thinking about this problem. Cost of living is nearly double what most of their employees are currently paying (meaning they'll have salary increases), but the synergies with other companies in their field (and a huge roster of nearby clients) makes it more worthwhile to them.

Aside from the obvious logistical issues, trying to price in such factors when setting regional tax rates might be awfully difficult.

[Lewkowski]

Oh yes lets make it more complicated...

Or we could enact the Fair Tax.

[Hazir]

As the article points out, it's usually only high income earners who can itemize and deduct the mortgage interest from their income taxes in the first place. That says nothing about the middle or lower income earner who got snookered into a mortgage that's over half their annual income.

That's probably why getting rid of the deduction is political.

edit to clarify: Besides our tax codes being fubar, they are already "indexed" by region and income. Definitions of poverty are both local and federal, by who gets refunds or credits (as well as subsidies), affordable property prices and loan arrangements.

Congress and bankers want to use tax law to encourage certain consumer behavior (home ownership with mortgages) that benefit certain industries (banks, realtors, builders) that can create inflationary bubbles.

Looking at just the mortgage interest deduction won't solve any problem, because it's bigger than that.

Huh? people forego a huge tax deduction because they can't be bothered to itemize? Is there something I am missing here?

Overhere in Holland pretty much everybody who has a mortgage would deduct the interest.

[GGT]

Eric Toder, a fellow at the Urban-Brookings Tax Policy Center, a left-leaning Washington think tank, says that low- to moderate-income people—those who might have to stretch to afford a home—typically don't itemize deductions on their tax forms and so get no benefit from this tax break.

The main effect of the deduction, Mr. Toder says, is to lower the cost of borrowing for wealthier people, most of whom would own property in any case. The deduction also may have helped inflate the housing bubble by subsidizing mortgage borrowing, encouraging people to take on more debt than they otherwise would have.

Our tax code is crazy messed up. Lots of people don't itemize but end up getting back MORE than they paid. Then we have the AMT, which drives everyone nuts. Pretty much the only people who can play the game are CPAs or tax attorneys.

[Hazir]

And how does that work if they don't deduct their interest on their mortgage?

And wouldn't they get more if they would deduct interest on their mortgage?

It boggles my mind.

[wiggin]

US tax code is fantastically complex, largely due to the government's size (by far pulling in the largest amount of money of any bureaucracy in the world) and number of legislated exceptions. There is a 'standard deduction' that is better for most low-income and some medium-income families, and an option to 'itemize deductions' that is a comprehensive listing of living-related costs that can reduce your total taxable income. If your itemized deductions are lower than the standard amount (or if you're lazy), you don't get to deduct mortgage interest.

Now, most deductions (or actually, credits) are not 'refundable' - that is, they can reduce your tax burden to zero but not beyond that. For that, you'd need a 'refundable credit' - e.g. after you establish your taxable income, the amount of tax can be reduced or even refunded above zero by certain credits. This is a very limited number of credits - an 'Earned Income Credit' for very low income earners with children is probably the biggest one, coupled with a 'Making Work Pay' credit as part of the economic stimulus, a child tax credit, education credits, some weird pension credits, and a stimulus-related homebuyer credit. Otherwise, deductions and credits will not cause a refund, but rather reduce a tax burden to zero.

[Dreadnaught]

Part of the reason $250,000 is 'solidly middle class' in NYC is due to COL and housing costs....Metros with higher property values (and incomes) actually benefit more than others; their loans are higher, they pay more in interest, and have more in deductions. Also need to look at local property taxes....they're all out of synch from state-to-state.

NYC has some high property values for purchase, with relatively low property taxes, and they also have rent control.

I don't understand how having a higher mortgage doesn't translate to a net tax benefit. Yes, you can deduct more...but you are also paying more in interest. A two bedroom apartment in Manhattan could cost $1 million or more. Assuming a 5% interest rate and 30% down, that's 700k in debt. A couple needs to pay $5,000 a month just on the mortgage. Factor in maintenance and real estate costs and you have $75,000/year just to pay for a two bedroom apartment. You need to make a few hundred thousand dollars a year to afford that. But according to Obama, that means you're wealthy.

Separately, I don't know where you're hearing that real estate taxes in NY are low...or how rent control factors into it.

An interesting idea, Dread. I think that given the relative inflexibility of the labor market (even in the US), the tax wouldn't cause an immediate equilibrium shift in cost-of-living and population concentrations, so presumably there would be some advantages in the early stages. Furthermore, one can argue that places like NYC, the Bay Area, and other relatively expensive cities (e.g. Boston, Seattle, etc.) are not just by happenstance. People and companies move there to be in the company of other talent. 'Clustering' is an odd phenomenon, but it has its advantages. Those advantages translate into reasons to bear the higher cost of living, salaries, etc. Thus, people are effectively making a cost-conscious choice when they get a job in one of those locales - taking into account all of the tax ramifications and cost of living increases, they'll still take the job, even though in real terms they might end up with more wealth in a less popular city.

My wifey's company is thinking of moving from the Baltimore-Washington axis to the Cambridge/Boston area, and they have spent a lot of time thinking about this problem. Cost of living is nearly double what most of their employees are currently paying (meaning they'll have salary increases), but the synergies with other companies in their field (and a huge roster of nearby clients) makes it more worthwhile to them.

Aside from the obvious logistical issues, trying to price in such factors when setting regional tax rates might be awfully difficult.

Oh yes lets make it more complicated...

Or we could enact the Fair Tax.

Yeah, actually maybe this is a point in favor of flat taxes...15% is 15% everywhere and everyone just deals with it.

[Being]

Yeah, actually maybe this is a point in favor of flat taxes...15% is 15% everywhere and everyone just deals with it.

Most low to middle-middle income are for this. It's corporations and upper-middle and above income that oppose this.

[Dreadnaught]

Why would corporations and wealthy people oppose a 15% tax rate when they usually pay more than that?

PS- source?

[Hazir]

US tax code is fantastically complex, largely due to the government's size (by far pulling in the largest amount of money of any bureaucracy in the world) and number of legislated exceptions. There is a 'standard deduction' that is better for most low-income and some medium-income families, and an option to 'itemize deductions' that is a comprehensive listing of living-related costs that can reduce your total taxable income. If your itemized deductions are lower than the standard amount (or if you're lazy), you don't get to deduct mortgage interest.

Now, most deductions (or actually, credits) are not 'refundable' - that is, they can reduce your tax burden to zero but not beyond that. For that, you'd need a 'refundable credit' - e.g. after you establish your taxable income, the amount of tax can be reduced or even refunded above zero by certain credits. This is a very limited number of credits - an 'Earned Income Credit' for very low income earners with children is probably the biggest one, coupled with a 'Making Work Pay' credit as part of the economic stimulus, a child tax credit, education credits, some weird pension credits, and a stimulus-related homebuyer credit. Otherwise, deductions and credits will not cause a refund, but rather reduce a tax burden to zero.

Ok, funny, the principles applied are the same but execution is incredibly much more complicated.

Which reminds me, I will have to file in the next few weeks. It will take me about 20 minutes, 15 of which are for putting the relevant papers on a stack.

[GGT]

I don't understand how having a higher mortgage doesn't translate to a net tax benefit. Yes, you can deduct more...but you are also paying more in interest. A two bedroom apartment in Manhattan could cost $1 million or more. Assuming a 5% interest rate and 30% down, that's 700k in debt. A couple needs to pay $5,000 a month just on the mortgage. Factor in maintenance and real estate costs and you have $75,000/year just to pay for a two bedroom apartment. You need to make a few hundred thousand dollars a year to afford that. But according to Obama, that means you're wealthy.

Separately, I don't know where you're hearing that real estate taxes in NY are low...or how rent control factors into it.

*sigh* Because you've forgotten our previous discussions on housing costs and property taxes by region or state. Higher mortgage does = tax benefit (an incentive that contributed to the bubble). Banks also sold interest-only loans just to make monthly payments 'affordable'.

Catch a look at MLS and the property taxes between areas, even LI or Bronx, compared to Limbaugh's $14 million Fifth Ave property. His $72,000 yearly tax bill is a steal, as percentage of property value. Ditto for Californians that didn't want to raise property taxes to fund their state budget. <A $500,000 home in CA or NYC has a fraction of taxes compared to one in PA.>

Manhattan is expensive, but you chose to live there and buy property, instead of a rent-controlled lease or going elsewhere. If you're looking for sympathy for how pricey Manhattan is, you'll be hard pressed to find pity or special considerations from anyone but fellow Manhattanites.

Urban buyers like to figure how much they save not needing a car, auto insurance, gas and parking costs....and put that toward housing costs. Also to deduct mortgage interest payments to pay less taxes. Don't forget you pay less property tax than many others do, as % of property value.

[GGT]

Ok, funny, the principles applied are the same but execution is incredibly much more complicated.

Which reminds me, I will have to file in the next few weeks. It will take me about 20 minutes, 15 of which are for putting the relevant papers on a stack.

Thanks, rub it in.

[Dreadnaught]

*sigh* Because you've forgotten our previous discussions on housing costs and property taxes by region or state. Higher mortgage does = tax benefit (an incentive that contributed to the bubble). Banks also sold interest-only loans just to make monthly payments 'affordable'.

Catch a look at MLS and the property taxes between areas, even LI or Bronx, compared to Limbaugh's $14 million Fifth Ave property. His $72,000 yearly tax bill is a steal, as percentage of property value. Ditto for Californians that didn't want to raise property taxes to fund their state budget. <A $500,000 home in CA or NYC has a fraction of taxes compared to one in PA.>

Manhattan is expensive, but you chose to live there and buy property, instead of a rent-controlled lease or going elsewhere. If you're looking for sympathy for how pricey Manhattan is, you'll be hard pressed to find pity or special considerations from anyone but fellow Manhattanites.

Urban buyers like to figure how much they save not needing a car, auto insurance, gas and parking costs....and put that toward housing costs. Also to deduct mortgage interest payments to pay less taxes. Don't forget you pay less property tax than many others do, as % of property value.

I do remember. Do you remember when I discussed how real estate taxes here are calculated? The MLS system doesn't work the same here because of how the city values things. Buildings like Rush are assessed based on building value according to an arcane formula that sums up the theoretical rental value of every apartment of the building, averages it with the past five years of valuations and then tacks on a number that's basically arbitrary if the city needs money.

I also don't think you remember that you can't just go out and find a rent controlled apartment.

But my point isn't to complain about expenses per se. My point is that expenses vary, and it's stupid for Obama to not recognize that costs of living vary from place to place, and in turn call anyone who makes above $250k "wealthy" for tax purposes. Thriving urban centers tend to be net contributors to the federal tax base, but he's trying to strangle them.

[Hazir]

For Obama? Like he's the first president not regionally indexing federal taxes? And strangling thriving urban centers? We're a bit heavy on the hyperbole today aren't we?

[GGT]

I do remember. Do you remember when I discussed how real estate taxes here are calculated? The MLS system doesn't work the same here because of how the city values things. Buildings like Rush are assessed based on building value according to an arcane formula that sums up the theoretical rental value of every apartment of the building, averages it with the past five years of valuations and then tacks on a number that's basically arbitrary if the city needs money.

We all agree--the way RE values and taxes are calculated are fubar. But for fun, take your property value and divide it by 45. That's what I pay on my house in school and municipal taxes annually.

I also don't think you remember that you can't just go out and find a rent controlled apartment.

Most of us can't. That NYC even has rent control is a symptom of the problem.

But my point isn't to complain about expenses per se. My point is that expenses vary, and it's stupid for Obama to not recognize that costs of living vary from place to place, and in turn call anyone who makes above $250k "wealthy" for tax purposes. Thriving urban centers tend to be net contributors to the federal tax base, but he's trying to strangle them.

Depends on how you look at it. Rolling back previous tax cuts still puts that bracket paying less in percentage than the 90s. State taxation is the bugger, but it's already indexed to COL, as far as I can tell.

[Dreadnaught]

For Obama? Like he's the first president not regionally indexing federal taxes? And strangling thriving urban centers? We're a bit heavy on the hyperbole today aren't we?

No, but Obama has campaigned aggressively on the idea that any tax increases he has to push for his bloated budgets will "only" impact "the rich". My objection is that his/the government's concept of "rich" happens to suck the life from places with higher costs of living.

[GGT]

No, but Obama has campaigned aggressively on the idea that any tax increases he has to push for his bloated budgets will "only" impact "the rich". My objection is that his/the government's concept of "rich" happens to suck the life from places with higher costs of living.

uh huh. Then define "rich" for us.

Also, while you're at it, explain why NYC and Wall Street should be considered the Financial Capital of the World.