Wednesday, August 20, 2008

Often Unrecognized Influence of Federal Income Tax Policy

Because the federal income tax is the largest and most costly tax in our country, it also influences economic behavior more than any other tax. Businesses take into account tax avoidance strategies into their decisions about what new investments to make in plant and equipment, how much inventory to hold, and even whether to show profits and declare dividends.

One of the most influential tax policies regards the deduction for mortgage interest. I can't remember where I read it, but I'm pretty sure that Americans spend more per capita on personal housing than any other nation. Wealth that could be used to invest in business is invested in housing that tends to be excessive relative to the rest of the world.

You want to see where the Reagan tax cut went, go drive along Bonneville shoreline into the various subdivisions where mansions exist that provide housing that is excessive for anyone's need. Americans with their houses live like Dukes and Earls, not the burgesses (bourgeoisie) that most capitalists pretend to descend from.

Go to places like Eagle Mountain and Saratoga Springs, and you see one case after another of people on fairly modest means occupying houses barely within or outside of what they could afford without the income tax considerations. For most people, the most valuable assets they have are their houses. Investments in the private sector tend to be retirement related if they exist at all for many Americans, and often, because of tax considerations, their houses have second mortgages on them to pay for everyday living expenses. This creates a dependence upon the value of one's house as the only asset one can exploit. And when the housing market goes down? Many are left with few options.

I believe our country would be better suited to pursue wise, and frugal residential land use. People don't need to live in a starter mansion, or have three or four mansions. I believe there should be a cap on the mortgage interest deduction of around $20,000 per year. This won't prevent people from getting into a home, but it will limit the incentive to overbuild and over-invest in real estate rather than in plant and equipment. Investments in plant and equipment increase American productivity. Investments in real estate, create short-term, and limited returns that ultimately do little for our economy.


Cameron said...

Taxes are a huge way that government can influence, if not outright control, the economy. Taxes themselves influence personal and business decision making, but then tack on the myriad deductions and credits and behavior seriously changes.

Capping the mortgage deduction at $20k is an interesting proposal. I wouldn't mind also considering removing or otherwise adjusting the second home mortgage deduction.

As a side note, most Eagle Mountain residents are there because it's the only affordable place left to live.

Obi wan liberali said...

Good points Cameron. As for Eagle Mountain, I view it as a place where people can get more land at a lower price so they can build more square footage into their homes. Atleast that is my perception.

Cameron said...

I wouldn't necessarily say "more land", as lot sizes aren't all that big. However, the cost per square foot is likely quite a bit cheaper than other places. And that's just a product of being in the middle of nowhere.

But your point that many EM residents wouldn't have been able to buy as big a house, or any house at all, without the mortgage deduction is true. And that's largely true of almost every home. The deduction is there to provide a means and an incentive to buying a home. It's the American Dream, after all.

It's the same reason we gave federal credits for implementing energy efficiency measures in the home, or buying hybrid cars, or donating to charity. These are all behaviors the government incentivizes through the tax code.

Jason Katzenbach said...

You left out "mortgage crises" from your list of things that excessive investment in realestate causes. Good post all the same though.