Chairman’s Report – April 22, 2016

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  • Source: FAIRtax
  • 04/09/2021
What Is The Difference Between A Deduction And Credit?
The income tax code contains both credits and deductions.  An example of a tax credit is the Child Tax Credit that allows a $1,000 credit for children under age 17.  This means that a family owing $4,000 in federal taxes will be able to reduce their tax liability by $1,000 for each child. 
In contrast, a deduction does not apply directly against the income taxes owing.  If your income tax rate is 20% and your deduction is $1,000, then you are able to get back $200 of the taxes you paid.
Taxpayers are only allowed to list deductions if they do not take the standard deduction of $6,300 for a single person and $12,600 for joint filers.  Since nearly 70% of income tax filers don’t have enough deductions, they choose the standard deduction.
It is important to remember that deductions and credits are only needed if you pre-tax consumption because they allow you to recover income taxes that you have already paid.  It is your money that the credit and deduction allow you to get back.
How Does Congress Decide Which Deductions Are In The Income Tax Code?
Deductions and credits in the income tax code are a good example of the statement, “The road to hell is paved with good intentions.”  Congress has decided that certain types of behavior should be rewarded and the best way to do that is with money.  These deductions are one of the main reasons that the income tax code has become so complicated and why it is considered by many unfair.

Of course, the purpose of a deduction is to make it less expensive to take the action encouraged by the income tax code.  This means that people who itemize their deductions can use some of their income taxes that would have been paid to take the action whether it be purchasing a home or making a donation to a charity. 
What Is The Mortgage Interest Deduction (MID)?
The MID allows people who finance their homes with a mortgage to deduct the amount of interest they pay on the mortgage—if they itemize their deductions.  This means that the cost of purchasing a home for the taxpayer whose deductions exceed the amount of the standard deduction can be reduced.
For example, if someone has a $300,000 mortgage at 4.25%, in the first year they will pay $15,279 in total payments.  $12,651 of these payments is interest.  If the taxpayer is in the 25% tax bracket, they will be able to recover $3,216 of the taxes that they paid.
While this is a benefit, under the FAIRtax, if the home was used, the purchaser would be able to use 100% of their income and not simply recover some of their pre-taxed consumption. 
Has The MID Worked To Increase U.S. Home Ownership?
The best way to answer this question is to see how the U.S. compares to other countries.  In 2015, the U.S. had a 63.4% home ownership percentage.  Canada does not have a MID but has a 67% home ownership percentage.  In fact, 23 of the 28 countries in the European Union had a higher home ownership percentage than the U.S.
In a study entitled Mortgage Interest Deductions and Homeownership: An International Survey, done for the Swiss Finance Institute, it is stated:

The empirical evidence suggests that, contrary to popular wisdom, the MID generally does not increase the ownership rate. This result is likely due to the fact that the MID is capitalized into house prices, especially where housing supply is inelastic.

Who Does The MID Really Benefit?
Of the taxpayers reporting an income of $50,000 or less, fewer than 10 percent use the MID and they saved just $150 more than simply taking the standard deduction and not itemizing.  In stark contrast, the average effective tax saving for a filer earning between $100,000 and $200,000 is $1,420—nearly 10 times larger than the $150 saved by low-income taxpayers using the deduction.

This is important because the MID benefits reduce the amount of tax paid and, therefore, require income tax rates to be higher to compensate for the taxes not paid.
Does The MID Actually Increase Home Prices?
In a study for the Mercatus Center, it was concluded, “Because the MID increases the demand for housing, the deduction has increased home prices by between 10 and 15 percent. Also, a greater demand for housing increases the demand for debt. As a result, higher interest rates may offset between 9 and 17 percent of the MID’s benefit for taxpayers.”
This means that if the price of the $100,000 home is reduced to $90,000, the homes are much more affordable.  First, if you need to make a 20% down payment your down payment is reduced from $20,000 to $18,000.  Second, if you finance the balance of the home cost with a 30 year mortgage at 4.25%, here is the comparison:

In this illustration, the home purchaser paying an additional $40 per month which totals $14,188 over the life of the loan.  Few of the people purchasing this price of home take the MID because the savings from the standard deduction are better than itemizing.  ($12,600 for a married couple and $6,300 for a single person as contrasted with the $3,900 of mortgage interest under the loan.)
Doesn’t The FAIRtax Tax New Homes As A Retail Purchase?
The FAIRtax treats the purchase of new homes as a taxable purchase and the FAIRtax will apply to the price.  While a person purchasing a new $100,000 home will pay an additional 30%, or $30,000, this is not different than what is happening now.  The person who purchases any home, new or used, will have to earn a minimum of $130,000 to be able to net, after taxes, $100,000. 
Of course, it is generally accepted that the enactment of the FAIRtax will allow competition to drive prices down from 10% to 15%.  If the $100,000 house is reduced in price to $90,000, the FAIRtax will be reduced to $27,000.  Since most people will be financing their purchase, the FAIRtax will be spread over the life of the loan. 
However, there is a huge difference.  Instead of only having the ability to recover part of the taxes that were taken out of your check, pre-taxing consumption, all payments on the home will be from 100% of your earnings. 
To summarize:
  • The MID is only useful to higher income people and only necessary when you pre-tax consumption. Now, our income is taxed before we get it, and if we save it there is a tax on the earnings.
  • If you look at the idea of making homes more affordable, doesn’t it make sense to not tax our income until we spend it?  Then 100% of our money can be allocated to savings which will grow with no reduction due to income taxes. 
  • While the MID helps higher income people with the MID, they are still paying for the principal of the home with after-tax dollars.  If the purchase price of the home is $100,000 and you are in the 25% income tax bracket and pay 7.65 FICA as an employee, you need to make $150,000, to pay the taxes and net $100,000.  
  • The MID and other deductions and credits only allow you to get back some of your money that was taken for income taxes—it is not new money. 

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