If you ask most politicians, government officials or realtors, they will tell you that the Mortgage Interest Deduction (MID), valued at $77 billion, is vital and without it home ownership would collapse. In reality, it does little to expand home ownership: (1) only 30 percent of taxpayers itemize deductions necessary to claim the MID, and (2) that two-thirds of the benefits from the MID—as measured by the effective tax reduction—go to households earning more than $100,000, households that can generally buy a home without assistance. In stark contrast, the FAIRtax would directly benefit all homeowners by making homes more affordable.
One way to properly measure the “true” cost of purchasing a home is using the wages that a family has to earn to be able to purchase that home. Let’s compare this for a family who buys a new home today under the current income/payroll tax system and under the FAIRtax. Assuming current market averages, we assume that they purchase a new home for $350,000, make a 15% down payment, and obtain a mortgage for the remaining $297,500.
True Cost of Purchasing a New Home (Wages that must be earned to buy a new home)
| Components of Housing Costs | Current Tax System | FAIRtax System |
|---|---|---|
| Difference in Total Housing Cost | -8.57% | |
| Total Housing Cost including taxes | $638,178 | $583,465 |
| Taxes | $110,710 | $105,000 |
| Income Taxes on Principal | $74,375 | $0 |
| Income Taxes on Interest | $0 | $0 |
| Payroll Taxes on Principal | $22,759 | $0 |
| Payroll Taxes on Interest | $13,576 | $0 |
| FAIRtax on New Home Price | $0 | $105,000 |
| Interest paid on 30 years | $177,468 | $128,465 |
| Mortgage Interest Rate | 3.40 | 2.55 |
| Home Mortgage Amount | $297,500 | $297,500 |
| 10% Down Payment | $52,500 | $52,500 |
| Home Purchase Price | $350,000 | $350,000 |
In the chart above, we compare how much the current system’s MID benefits the homebuyer relative to the FAIRtax system’s full non-taxation of interest and principal payments on mortgages by drawing only the most conservative assumptions. To purchase the $350,000 home mentioned above (assuming a 30-year term and a fixed rate mortgage rate of 3.40 percent), the prospective homebuyer would have to pay $177,468 in interest in addition to the price of the home. Since the current tax system taxes both income and payroll, these taxes must be taken into account when figuring out how much the family would have to earn over the term of the mortgage to pay it off. Taking these taxes into account, our homebuyer would have to earn $638,178 to pay off the mortgage over 30 years.
In contrast, the FAIRtax does not tax earnings, and instead taxes consumption – in this case the purchase of the new home. Thus, although our homebuyer will pay sales taxes of $105,000 on the price of the home, they only have to earn $583,465 to completely pay off the mortgage – an amount that is 8.6 percent less than they do today. This results from two factors: (1) the entire mortgage payment is made with untaxed dollars, not just mortgage interest; and (2) mortgage interest rates are projected to drop by 25 percent.
In this example, we have not considered the economic growth and higher real wages that would occur by removing the drag on the economy from the income tax, even though few economists dispute the pro-growth impact of the FAIRtax.
Conclusion
In order to match the power of the FAIRtax for encouraging home ownership, the current tax system would have to at the very least:
- allow all taxpayers to fully deduct the purchase of real property against income and payroll taxes,
- expand the mortgage interest deduction so that it permits a deduction against payroll taxes,
- fully untax interest income to lenders and institutions,
- fully untax the returns on savings, and
- stimulate economic growth and promote higher real wages.
Policymakers who profess to support home ownership should take note. The FAIRtax is far superior to current law.
Dr. Karen Walby, Ph.D.
Director of Research
Americans For Fair Taxation