The president's advisory panel on federal Tax Reform released its final report on Nov. 1, 2005. The recommendations, if enacted, would wreak havoc on the housing sector by cutting or eliminating current tax incentives for primary residences, second homes, remodeling, and low-income rental housing.
WHY TAX REFORM? The only real driver of fundamental change in the tax code is the persistent spread of the alternative minimum tax (AMT) from the original super-high-income parties that paid no taxes and into the middle-income classes, where ordinary people pay plenty of taxes. Indeed, the tax panel says that the AMT, if left alone, will increase taxes for more than 21 million taxpayers in 2006 and 52 million taxpayers by 2015—and that the AMTwould raise about $1.2 trillion over that 10-year period. That's certainly an absurd outcome for a tax provision that obviously is running amok!
So why not just fix or eliminate the AMT? Because scaling back or doing away with the AMTwould create a huge revenue “hole” that, as such, violates the president's mandate to make tax reform “revenue neutral”—i.e., a new system must raise as much tax revenue as the current system would over the next 10 years. Instead of possibly fixing the AMT problem and cutting federal spending below current projections, revenue neutrality was mandated to preserve the projected federal budget deficits.
WHY ATTACK HOUSING? The tax panel is not responsible for the tax-increase exercise mandated by the twin requirements of AMT elimination and revenue neutrality—those came from the White House. The president also instructed the panel to emphasize simplicity and fairness, to remove blocks to economic growth, and to preserve special incentives for a few things, including homeownership. The panel certainly had no mandate to strip decades of economic and social policy from the tax code. But the panel took the position that an economically neutral tax code—i.e., a code that doesn't favor one type of economic activity over another—will lead to a more efficient use of national economic resources, and it charged ahead on this premise.
The panel said that current tax law directs too much capital into housing, particularly to the higher end of the market, and that reform should shift capital to “productivity enhancing” investment—meaning investment in business equipment and structures. Thus the panel proposed major cuts in all housing tax incentives, including the substitution of a limited tax credit for the home mortgage interest deduction, the elimination of the deduction for property taxes, and the elimination of deductions for second homes and home equity loans. It even recommended eliminating the low-income housing tax credit, the only federal incentive for the production of low-income rental housing.
WHERE'S IT GOING? Members of Congress have already taken serious issue with the proposition that housing incentives should be stripped out of the tax code to help finance AMT elimination. And there is a chorus of credible voices screaming that the panel's proposals would cause major house price declines, damage the financial system, and threaten the economic expansion. There has got to be a better way to ease growing AMT pressures without blowing future budget deficits out of control, and the search for an answer should include an examination of both the expenditure and revenue sides of the federal budget.
Chief Economist, NAHB Washington, D.C.
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